A dividend is a sum of money paid regularly by a company to its shareholders out of its profits or cash reserves. In the US this is typically paid on a quarterly basis but occasionally half-yearly or annually. Such dividends may be paid in cash, property, or in shares of the Company’s capital stock. The dividend yield is the sum of these payments made during a period of 1 year and divided by the value of the asset.
Mature industries tend to pay higher dividends as there are fewer opportunities for capital investment. Growth companies such as those in the technology or bio-technology space however are unlikely to pay dividends for many years as capital is constantly reinvested in the business. If this is the case, investors sometimes choose to make their own dividends buy selling a fixed dollar value of their stock to create a cash payment whilst paying heed to the appropriate tax treatment.
Once the dividend has been declared, stockholders that are on the shareholder register at a certain date, known as the “ex-div” date will be entitled to payment of the dividend. At the time the stock is known to “go ex-dividend” or “ex-div” the price drops by the dividend amount. This decline represents the reduction in the value of the firm as funds are transferred from the firm the investor. In this way, there is no free lunch of buying a stock, collecting the dividend, then selling the stock for the same price. In real life, when the stock price adjusts following a dividend payment, it may not move by the exact amount of the dividend as the stock will be subject to various other market forces effecting the stock price on that day.
Example of a Dividend in Merger Arbitrage Trading
Many data providers and merger arbitrage commentators often forget to include dividends when calculating and trading merger arbitrage. Traders need to study the merger agreement and find out if dividends will continue to be paid and if so, how much and for how long. Traders should also look for whether payment of a stub period dividend is required. A stub period dividend is a dividend that is paid for a shortended period of time pro rata to the full dividend. Individual tax treatment should also to be considered. When a trader has all the information, the total return can be calculated accurately.
As per a recent 10-K filing by Cypress Semiconductor on February 21, 2020, a dividend is described as
The holders of outstanding shares of the Common Stock are entitled to receive dividends when and if declared by the Company’s board of directors (the “Board”), subject to the limitations of the DGCL and the Certificate of Incorporation. Such dividends may be paid in cash, property, or in shares of the Company’s capital stock.
Merger Arbitrage Limited has written extensively on trading stocks that pay dividends in takeover situations and how they can affect profitability. You can read more in our articles Trading Merger Arbitrage – A Practical Guide and Calculating Stock Based Merger Arbitrage Spreads – Barrick (ABX) & Randgold (GOLD) – An Example.
