How Dividend Policy Affects Expected Stock Returns

We have asserted that share repurchases provide a better method of distributing cash than dividends because most investors prefer capital gains income to an equivalent dividend taxed at a higher rate. Stocks with higher dividend yields, to compensate investors for their tax disadvantage, should thus offer higher expected returns than similar stocks with lower dividend yields. Firms with higher dividend yields, but equivalent cash flows, should then have lower values, reflecting the higher rates that apply to their cash flows.

Researchers have taken two approaches to evaluate the effect of dividend yield on expected stock returns. The first approach measures stock returns around the date that the stock trades ex-dividend. Recall from Chapter 8 that the ex-dividend date (or the ex-date) is the first date on which purchasers of new shares will not be entitled to receive the forthcoming dividend. For example, a dividend paid on February 15 may have an ex-dividend date of February 5, which means that purchasers of stock on and after February 5 will not receive the dividend. Since investors who purchase the stock before the ex-dividend date (February 4 or earlier in this example) receive the dividend while those who purchase stock on or after this date do not, the decline in the stock price on the ex-dividend date provides a measure of how much the market values the dividend. The second approach measures how dividend yield affects expected returns cross-sectionally.

7See Black (1976) for an early discussion of this dividend puzzle.

Ex-Dividend Stock Price Movements

Consider Example 15.4, which assumes that a dividend is taxed at an investor's personal income tax rate and that capital gains are not taxed at all.

Retirement Planning For The Golden Years

Retirement Planning For The Golden Years

If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.

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