Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.
A company sets the dividend that they will pay per share. But individual investors can also set their own per-share dividend level through a method known as homemade dividends. Read this lesson to find out how to create homemade dividends.
Bob owns 10 shares of stock in a building company. Each stock is worth $100, so Bob has $1,000 invested in the company.
The company just announced that they will be giving a cash dividend, which is a payment to each of the shareholders from the company's profit for the quarter. They will pay $2 per share for the quarter. That's $20 that Bob will receive.
$2 per share is nice, but Bob would rather earn $3 per share. Bob knows he's not going to change the company's mind. However, there is a method whereby he can make $3 per share. Let's help him out by introducing him to homemade dividends.
We know Bob owns 10 shares of stock in the building company. He's about to get $2 per share (a total of $20), but he wants $3 per share. So, what can he do to get what he wants? To understand how Bob can increase his per-share dividend, we first need to understand something called the ex-dividend date. Any stock sold on or after this date will have their dividends go to the seller of the stock, not the buyer. The ex-dividend date is usually about a week after the company declares that there will be a dividend and how much it will be.
So, what does the ex-dividend date have to do with Bob's strategy to increase his per-share dividend? Let's say that, on or after the ex-dividend date, Bob sells four of his shares. Now, instead of having 10 shares, he has six shares. But he will be receiving the $2 dividend on all 10 shares, so he's still receiving $20.
But something has changed. Now, Bob only has six shares in the company, so his per-share dividend is actually $20 divided by six, which is $3.33. His per-share dividend has gone up from $2 per share to $3.33 per share, even though his total dividend has not.
When investors sell shares ex-dividend in order to increase their per-share dividends, it is called a homemade dividend. Bob's homemade dividend increased his per-share dividend by $1.33.
Does it Matter?
Even though Bob's per-share dividend has increased from $2 per share to $3.33 per share, he's still only getting $20. The total dividend has not increased. So, is it worth it to do as Bob has done, and create homemade dividends?
Perhaps and perhaps not. Many people point out that, under most circumstances, homemade dividends don't add anything of value. That is, in most circumstances, it's better for investors to not bother with homemade dividends.
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But there is at least one case in which homemade dividends can make sense: if you'll be selling your stock anyway. For example, let's say that Bob knows that he needs to buy a new car soon, so he was already planning to sell four shares in the company when he got the news that there would be a dividend. In that case, it might make sense for Bob to wait until the ex-dividend date in order to receive the dividend on stocks that he would have sold anyway.
However, this method can also backfire because stocks are volatile and often increase just before the ex-dividend date and fall on or in the days following the ex-dividend date. For example, the stock may be worth $12 the day before the ex-dividend date, but only worth $9 on the ex-dividend date. In that case, Bob would be better off financially if he sold the stock at $12 and skipped the homemade dividend increase.
A cash dividend is a payment to each of the shareholders from the company's profit for the quarter. To increase their per-share dividend, some investors sell shares after the ex-dividend date, or the date on or after which the seller of a stock will earn the dividend. This method produces a homemade dividend for the seller.
Under most circumstances, homemade dividends don't add anything of value because they don't increase the overall dividend. In some cases, such as when an investor is planning on selling stock anyway, homemade dividends might add value, though the volatility of stock prices around the ex-dividend date means that the homemade dividend method might backfire and cost the investor money.
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