Trader Toolkit: Dividends

With the ever-increasing number of  trading platforms and the growing allure of low-to-no-fee brokerages, new traders are confronted with a deluge of options when it comes to trading and investing. But lost in the promises of sleek interfaces and free shares for signing up is the fact that successful trading takes time, practice and an understanding of resources experienced traders use on a daily basis.

Using the charts and tools available on the Webull trading app, which offers zero-commission trading and a suite of advanced trading analysis and charting, the Trader Toolkit series of articles will aim to explore the ratios, indicators and signals that play an integral role in how traders generate ideas and form convictions on their medium- or short-term trades.

Among the many metrics by which traders gauge the value of a stock, dividends are seemingly one of the more straightforward.

And on their surface, dividend programs are pretty straightforward. Typically every quarter (but occasionally just once or twice a year) some companies will pay shareholders a portion of the profits the company generated over the previous fiscal period on a per-share basis. Essentially, the company is paying its active stakeholders for helping it be as profitable as it is, which can be a pretty nice bonus if the company’s equity is already rising.

Of course, digging even a tiny bit deeper into what role dividends actually play in relation to a stock’s value reveals a much more complex value proposition.

For one, companies don’t just pay bonuses out to any day trader who might be holding shares. Companies that plan on issuing a dividend follow a pretty rigid process for their payouts that begins with the announcement of the dividend, or the declaration date.

In addition to outlining the dollar value of the upcoming dividend, the declaration also cements a timeline of events over the next 6-12 weeks that traders and the company must adhere to. The declaration date makes the whole process official and the company is legally obliged to issue the dividend on the states date to all applicable shareholders.

Applicability is actually a key concern when it comes to dividends. The most important dates traders pay attention to when it comes to dividend distributions are the ex-dividend date and the record date, which take place on two consecutive days a few weeks prior to the payout.

In truth, the ex-dividend date isn’t “announced” inasmuch as it is derived from the date that follows it, the record date, which is the day on which the company makes a record of all of the shareholders who will receive a dividend payment. However, of the two, the ex-dividend date is far more important.

Although the record date is the day on which the company makes a record of all of the shareholders who will receive a dividend payment, the settlement period between buyers and sellers can take a day or more. As a result, the day before the record date, the ex-dividend date, is the actual cut-off point for anyone looking to receive a dividend payment.

This is important for two reasons. The first is that traders looking to collect a dividend need to own or purchases the stock the day before the ex-dividend date. The is other important factor to consider is that, once the ex-dividend date arrives, the stock will generally trade lower, since anyone buying shares on or after the ex-date will no longer have the added income of the dividend to look forward to.

We’ll get into the implications of that later. For now, take a look at the breakdown of the dividend timeline in a stock with a fairly consistent dividend program, Clorox Co. CLX, using the company announcement tools on the online trading platform Webull.

As outlined, this breakdown shows the declaration date, the ex-dividend date and the payout date as well as both the size of the upcoming dividend and Clorox’s annual dividend which, since they have historically issued a dividend every quarter for the past +20 years, is four times the size of its upcoming dividend.

This brings up the topic of the kinds of companies that issue dividends. While many companies might explore a dividend program, there are generally two reasons why a company might institute one. For companies like Clorox, whose shares typically appreciate very slowly over a long period of time, a dividend serves as an added source of income for investors who buy and hold the stock over an extended period. Other slow-growth stocks like Dominion Energy Inc. D and McCormick & Co. MKC are also known for their long-standing dividend programs.

The other reason a company might issue a dividend is to attract more investors by offering a slice of the company’s revenue. However, while this may be a well-founded decision for extremely profitable companies like Apple Inc. AAPL, other less successful companies might use dividends to lure unsuspecting investors into buying into unprofitable ventures.

Which goes to illustrate exactly how dividends function alongside the stock's share price. Even though the income received from a dividend payment is immediate, the market has generally factored in the value of that payment well before the ex-dividend date, and often, even before the declaration date.

Just look at how Clorox has traded around its recent dividend payments. While some of those disbursements have been affected by earnings or market conditions, it’s clear the stock is more volatile as it closes in on its quarterly dividend (as indicated by the the red D).

Trading around dividends is a popular strategy among advanced traders, and even passive investors can get a lot of added value by purchasing dividend-paying stocks. However, traders should remain aware of exactly what the risks and benefits are in buying shares of a stock for a dividend. Sometimes, the costs may outweigh the amount that’s paid.

Webull is a content partner of Benzinga.