Why Will Dividend Make Microsoft Stock Price Fall By Dividend Amount?
November 10, 2004 2:14 PM   Subscribe

According to numerous reports I've read in the last few days worth of the Business Section of the newspaper, Microsoft's "stock price can be expected to fall by the amount of the dividend." That's the one-time $3 dividend that is coming sometime soon for those of you who don't follow this sort of thing. Anyway... I don't get it? Why is the stock price expceted to drop about $3 the day after this dividend? I like to think of myself as knowledgeble about the markets, and I understand that this dividend will remove $3 per share out of the bank for M$, but aren't stock prices valued more in terms of the value of the company and its holdings rather than simply the value of the money in the bank?
posted by pwb503 to Work & Money (12 answers total)
Well, the reason you bought the stock is because you expect to be able to sell it at a profit. The dividend is $3 of that profit, except you get it without selling the stock. Thus, you are willing to accept $3 less for that stock when you sell it.

Another way to look at it is if you buy Microsoft stock today, before the dividend is paid, you are buying a share of Microsoft stock, plus $3 at a future date. Therefore the value of the share is the purchase price, less $3.
posted by kindall at 2:18 PM on November 10, 2004

(I would actually expect the stock's price to increase by $3 after the dividend was announced, then fall by $3 after it is paid.)
posted by kindall at 2:21 PM on November 10, 2004

But in theory the stock's price already reflects the value of the $3 in cash per share. Announcing that you will be giving it away shouldn't create value.
posted by smackfu at 2:24 PM on November 10, 2004

Yes smackfu, I agree with kindall's first comment, and mostly disagree with the second. You might see a *small* rise after a maiden dividend announcement, because small investors are bad at maths. Alternatively, you could argue that there is a little value in making the $3 available, whereas before it was locked up, so to speak.

pwb503, your question contains its own answer. You say "...aren't stock prices valued more in terms of the value of the company and its holdings..."? Yup. (Or at least, that's one way; another way is to look at a series of discounted future cashflows, but we won't go there for now). MSFT's "holdings" include that cash; once it's paid out, MSFT's value decreases by the value of the payment.
posted by i_am_joe's_spleen at 2:53 PM on November 10, 2004

But this doesn't make sense to me. The stock price is not correlated directly to the amount of cash they have in the bank - it takes into account a mixture of current assets and future expected profits. Theoretically, handing out the dividend should have no effect on the company's ability to do business, grow, or whatever, since it's a small amount of the money they have in the bank and I can't imagine that the interest income they're earning from it impacts on the bottom line in any way. Since it would just be sitting there doing nothing anyway, why's it influencing the stock price at all?
posted by Caviar at 2:57 PM on November 10, 2004

Stock prices are based on predictions of future income, rather than just current market value of assets. That is, most companies are "worth" whatever their stock sells for, not because you could shut them down, sell off their assets, pay their debts, and split up the rest among shareholders, but because you can expect to get some money in the future (dividends or capital gains) if you own the stock now.
As the money you are expecting to get in the future becomes the money you are actually receiving today, its value (as reflected in the stock price) changes. That is, if you knew that Microsoft was going to pay a $3 dividend tomorrow, you might be willing to pay almost $3 more for the stock today. On the other hand, if the dividend was going to be paid next week, you might only be willing to pay $2.50 more, because you'd be less certain that you would get all that $2.50 (plus a week's worth of interest) back.
I don't follow stocks particularly carefully, but I note that MSFT has gone up almost $2.50 over the past month and a half. That makes sense: it's becoming more and more certain that, regardless of whatever other dividends or capital gains you think you might get from owning the stock, you're going to get that $3. But once you get it, you can no longer expect to get it in the future. That's why the shares would fall back after the dividend is paid.
posted by spacewrench at 3:10 PM on November 10, 2004

Let's tease a couple of things apart here.

Stocks have a price. Purely and simply, it's the last sale or quote.

Some people also think stocks have an "intrinsic value" which may be higher or lower than that last quote. (I'm one of those people. Look up "efficient market hypothesis" and "technical analysis" for other schools of thought).

Intrinsic value is hard to assess, so there are several ways to arrive at it, depending on how much uncertaintly you can tolerate.

See, I know for sure how much cash MS has. I have a pretty fair idea what their property and fixed assets would be worth if sold. And I know what their liabilities if wound up are. The result, the so-called "book value", is a very conservative number. A company like MSFT usually trades well above book value. Nonetheless, if book value decreases, as it must when a dividend is paid, you will see a corresponding price drop, however temporary.

You can also, as spacewrench says, place a value on the money you expect to receive in the future. A conservative person would factor in no growth; they would just look at the current earnings, divide by the cost of capital, and come up with a number they know is on the low side. That's good, cause we know what current earnings are - we don't know what future earnings will be with certainty. If you see a stock trading at or below current earnings divided by cost of capital, either it is undervalued or everyone sees dire things ahead for it.

Now, note that a dividend payout this year decreases this year's earnings. A dividend is cash leaving the company, so it has to be accounted for somehow. So that's how it ties in with the earnings-based approach to valuation.

Note that the price only drops once the dividend is paid, and it drops by about the amount of the dividend. That makes sense, because if we keep holding the stock, we expect to receive the future dividends and they have a value too.

Lastly, we can have a notionally more "accurate" (and almost always much higher) valuation by trying to predict earnings for the next few years, and figuring out how they might be reinvested in the company, and estimating what rate of return the company might earn on those retained earnings. This is straightforward in a mathematical sense, but with year further out, and with each additionaly refinement to our valuation, we introduce more "noise", more margin for error. The value you see quoted is more like this last value, however: one common way to look at the quoted price is as the group consensus on what this complex prediction-based valuation is.

The consequence of all this is that if you are a "fundamentalist" like me, you only buy when you see stocks trading at or below your conservative valuation, if they check out in other respects.

I know this is a lot more than was originally asked, but no answer will make much sense unless you think about what "value" means in this context.

One possible answer is: MSFT will be worth $3 less if that's all people will pay. I don't find that a very satisfying answer, so then we need to look at what distinguishes value from price. There are many approaches to that, but they would all agree that a decrease in cash position is a decrease in value.
posted by i_am_joe's_spleen at 3:52 PM on November 10, 2004

posted by mr_crash_davis at 4:23 PM on November 10, 2004

If I buy a share of MSFT on Nov 16, I collect $3.00 on Nov 17, and still own the share. But if I buy it on Nov 18, I have the share, but not the $3.00.
posted by jjj606 at 5:12 PM on November 10, 2004

Am I the only person who remembered this previous question?
posted by mrgavins at 11:44 PM on November 10, 2004

would you really pay the same for the share, the day before and the day after it paid out a dividend? if so, and you own shares which are about to pay out, would you mind selling them to me, then buying them back after?
posted by andrew cooke at 5:27 AM on November 11, 2004

There are also people like me, who think that the markets are completely tainted with irrational exuberance.

Briefly: Americans are very wealthy, and have a lot of surplus wealth that they either invest, or hand to someone else to invest on their behalf, or hand to their bank, who invests it on their behalf.

There are also a lot of American corporations which are publically traded. Because of historical factors - track record - investors of American $ prefer to put those monies in the stock of American corporations. Foreign investment is perceived to be higher risk, so American $ are disproportionately invested in the American markets.

This ignores the fact that production of most goods is shifting out from America about as fast as it can do. As a result, the disproportion between the amount of money invested in the American markets and the amount of money that *should* be invested in the American markets if future risks and returns were correctly estimated continues to grow, resulting in inflated prices and P:E ratios (and every other index you care to name.)

More briefly: I am a crank. But I wouldn't put money in the U.S. stock markets on a bet.
posted by ikkyu2 at 12:47 PM on November 11, 2004

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