What is a dividend gap and why you should not be afraid of it

Shares of companies often become cheaper, at first glance, inexplicably. If there are no other obvious reasons, it is worth checking whether the company is going to pay dividends. Perhaps the dividend gap is to blame.

What is dividend gap

What is a dividend

Successful companies make a profit as a result of their activities. After all necessary payments and taxes, they have a sum that they can use to develop their business and reward their shareholders in the form of dividends. The percentage of net profit that is distributed to shareholders varies from company to company. Some companies decide to use all of their income to expand production and do not pay dividends. Other firms steadily transfer a fairly high percentage of their proceeds to shareholders, thereby attracting new investors.

A dividend is the portion of profit or free cash flow that a company pays to its stockholders.

Companies may pay dividends at the end of the year, six months, or a quarter. There are companies that do not pay dividends at all, directing all profits to development or being unable to pay them due to poor results. The amount of dividends is calculated by the company’s board of directors or supervisory board in accordance with the company’s dividend policy. The board makes a recommendation to the shareholders’ meeting, and the meeting makes the final decision on the payment of dividends.

Who decides on the payment of dividends?

It is up to the board of directors or other collegial management body to determine the recommended amount of remuneration. Authorized persons, guided by the dividend policy, submit a proposal on payments to shareholders, the amount of interest for approval by the general meeting of owners.

What is a dividend gap

During a dividend gap, a stock drops in value sharply. This happens immediately after the date on which the securities are traded, with dividends on the last day.

Let’s understand more about what this means and why it happens. To receive a dividend, you have to be a shareholder on what’s known as the cutoff day. On this day, the company lists the shareholders who are owed dividend payments. That is, it closes the shareholder register. It takes two days to re-register the transaction. This trading model is called T+2. That’s why you have to buy the paper no later than two days before the register is closed, otherwise you won’t receive the dividend.

If you buy securities the day before the register is closed, you won’t have time to get on the list and you won’t receive dividends. That is, on that day, you buy the stock already without a dividend.

dividend gap

How does a dividend gap start?

Let’s look at the situation in order. As soon as a company announces a dividend, many investors who want the dividend begin to actively buy its shares. In this case, the greater the potential dividend yield, the greater the interest of buyers in the stock. That’s why the stock rises for several weeks before the close of the shareholder register, which we mentioned earlier.
There are investors who take a risk and start buying stocks even before the dividend amount is announced. For example, already after the release of the company’s financial statements. Before buying, they calculate the possible amount of dividends themselves, based on the company’s dividend policy. However, here, there is a probability that the company will reduce the amount of dividends or decide not to pay them at all.
Many investors, who bought shares only for the sake of dividend payments, start selling them after it is no longer possible to get on the register. There are two reasons for this. First, investors sell shares because they are already on the list of shareholders who are owed dividends on certain shares. Second, if you sell right away, you can also make money on the stock appreciation that has been going on for the past few weeks.
Thus, when some investors start selling, others stop buying at those prices. This causes the price to plummet and a dividend gap to occur.

When does the dividend gap end?

As a rule, the dividend gap begins to close after the closing of the shareholder register, i.e. shares gradually rise in price after falling to previous levels.

The time it takes for the stock to reach previous prices can range from a few days to many months. Sometimes the price never recovers. The speed and completeness of gap-closing depend on many factors – its size, expectations for the company and its shares, political and macroeconomic factors. Dividend gaps can close faster if key rates fall. The economy – and therefore the market – generates more money and investors become more active.

Strategies for making money on a gap

A person who has decided to engage in investing for profit should think about building a simple system of actions to achieve optimal profits from transactions in valuable assets. An effective algorithm can be chosen from a number of strategies developed based on market analysis.

  1. An investor buys shares before the gap occurs (no later than two days before the cutoff date), gets on the list of participants for the transfer of dividends. After the close of the register, a price drawdown occurs. The owner is rewarded and does not sell the shares until their value rises to an acceptable level. The advantage of this tactic is the guaranteed income. The dividend gap is usually closed within a year, often in a few months, sometimes in a couple of weeks or even days.
  2. Purchase securities on the first trading day after the dividend list close. At that point, their price is lower than the previous day by the amount of interest paid. After the value of the shares returns to their previous price, they are sold at a profit.
  3. Another way to make money is to buy securities just before the dividend gap, then the price rises and overlaps the gap. The probability of overlapping is very high. The yield is good.
  4. Buy shares of companies with higher yields. Invest the interest paid to acquire the same securities at a low cost during the gap period. Assets will return a profit after the price recovers.

Kevin Doran

I have been trading forex since 2015. Over the past few years, I have tried and tested all the most popular Forex Brokers. I publish my reviews to help you choose a reliable broker and reduce your risks.

Rate author