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Why is the Ex Dividend Date so Important?

When corporations such as McDonalds or IBM have millions of shareholders trading their stock every single day, it is very expensive to keep track of each shareholder when it comes time to pay them dividends. Dividends are the portion of earnings that are re-distributed to shareholders in the form of dividends. Most companies pay dividends quarterly, while some do semi-annually and others annually. In order to simplify this problem, most corporations designate a date, known as the "record date." This is the date when dividends are paid to stockholders who hold stock as of the record date. Things get more complicated than this because when you purchase a share of stock, it takes a few days for the transaction to "clear" or "settle" in the stock exchange. To allow for such processing, stock exchanges set up a date, known as the ex-dividend date which is usually 2 days prior to the record date. Anyone who purchases the stock ON or AFTER the ex-dividend date is NOT eligible for the dividend payment. This is because the purchase of the stock will not settle by the record date.

The 3rd date you should be aware of is the dividend payment date, which is when the dividend check is actually sent to shareholders. For example, if you look at the record dates of dividends for July 1st to July 31st, 2010 (at the time of writing this article), we see BestBuy (BBY) as an Ex-dividend date of July 1st, 2010 while the actual payment of dividend date is July 27th, 2010. This means you must be a shareholder of Bestbuy BEFORE July 1st, 2010 in order to be eligible for the dividend payment.
Note: Even if you buy the Bestbuy stock on July 1st, 2010, you will still NOT be eligible for the dividend. It is only BEFORE the ex-dividend date.

After the close of stock markets before the ex-dividend date and before the market opens on the ex-dividend date, all stop limit and good-until-canceled orders are automatically lowered by the amount of dividends except if the investor indicates not to do so, filling a "Do Not Reduce" form. This is done so as to simplify the dividend payment process.

Timeline of Dividend Payments (CISI Certificate programme)

This is a fantastic video tutorial that shows how directors of a corporation decide if they will pay a dividend in the quarter or not. The professor gives an example if you buy a share of stock on a friday, which happens to be the ex-dividend payment date (see above for explanation), do you automatically get the dividend payment? Well no, because your name is not on the stock register, you will not get the dividend payment. This is because the register is NOT updated until the settlement date, which can be between 2-3 days after you buy the shares. I also like how the professor explains the Ex-Dividend date from the Latin word which stands for "No - Dividend" date (in other words Ex refers to the word "NO").

 

Important Terminologies from the Video

i) Ex-Dividend Period - Every day after the ex-dividend date is known as the Ex-Dividend period and this is the period when NO dividend payments willl be made to those shareholders who bought ON or AFTER the ex-dividend date.

ii) Cum-Dividend Period - This is the period (days) before the ex-dividend date where if you purchase a share of stock in this period, you will be eligible for the upcoming or next dividend payment. Cum stands for "With" from the Latin language. Thus, Cum Dividend means "With Dividend."

iii) Important note about the ex-dividend period is if you are the seller and sell the stock on or AFTER the ex-dividend date, you still get to keep the dividend payment because you are selling the stock EX-Dividend which means "Without the dividend".

iv) If you are the buyer and buy the stock during the Cum-Dividend period, then you as the buyer will be eligible to receive the dividend payment because you are buying CUM-Dividend or "With Dividend."