Finance theory disagrees with you.
A dividend lets the investors choose if they want to buy more shares (from the same sellers who would sell in a buyback) or mix their current shares with the cash.
A dividend lets the investors choose if they want to buy more shares (from the same sellers who would sell in a buyback) or mix their current shares with the cash.
The key is the asymmetry of information. The market price should reflect all public information. However the company has non-public information, which puts them in the best position to judge if money is best invested inside the company or out. Share buybacks are a legal form of insider-trading.
Reducing shares increases the price (while keeping market cap the same). Share splits increases the shares outstanding and decreases the price. So... yes, shares outstanding does matter.
You're wrong. When the company issues the dividend, the share price falls for precisely the amount issued. So if everybody used that money to buy the shares again, the share price should return (roughly) to the value before the dividend was paid. The number of shares outstanding wouldn't change.
Say you own 1 share. It's trading for $20. Tomorrow the company pays $2 dividend. Then your share is worth $18 and you have $2 cash as well.
Alternatively, if you're buying the share, you're willing to pay $20 for it today but only $18 tomorrow, because you know that you won't be getting a $2 dividend if you buy it.
If you take future dividend payments into account, you also need to discount them. If you think that (discounted future dividends) > (stock price), that's a signal for you to buy. If enough investors reason this way, the price will rise until (discounted future dividends) ~~ (stock price).
Before dividend:
P = D_0 + δ D_1 + δ^2 D_2 + δ^3 D_3 + ...
P = δ D_1 + δ^2 D_2 + δ^3 D_3 + ...There is a value in a future dividend. On the ex-dividend date, the share becomes less valuable because the new holder will not receive a dividend in X days. This X is usually very small, so a share that goes from paying you $5 in two weeks to not paying you has clearly lost value close to $5.
If your argument was true, that a stock's price predictably fell the day after the dividend, investors could simply short the stock and get a guaranteed profit, which is not possible in an efficient market.
False. If I receive cash today I can reinvest it and start earning a return. If I receive cash in a month I have forgone one months reinvestment return.
> investors could simply short the stock and get a guaranteed profit, which is not possible in an efficient market.
False. Well if you are short a stock over ex dividend date then you need to pay the owner of the stock (whomever you borrowed from) 1) the dividend which he has forgone 2) a financing spread equal to a benchmark (e.g. FED Funds + 300 bp's) for the duration you are short.
No offense but you really haven't thought this through very hard.
Also markets are not efficient despite what you read in academia.
The ex-dividend rate is an implementation flaw that makes the stock price discontinuous at the dividend date. If dividends were pro-rata it would not be.
I never said markets were perfectly efficient.
You didn't think through your answer very hard did you? ;)
They do. But you don't usually see this, because the prices are "adjusted", to make price history continuous, same as with stock splits.
Take a look at MSFT (Microsoft) stock price on Yahoo! Finance. "Close" is what actually happened, and "Adj Close" is what you see on the graph.
Date close Adj Close*
16 Feb 2016 51.09 51.09
16 Feb 2016 0.36 Dividend
12 Feb 2016 50.50 50.14
* Close price adjusted for dividends and splits.
> investors could simply short the stock and get a guaranteed profit
No, to short a stock you need to borrow it first. If you borrow a stock, you owe the dividends that were due in the meantime.
When shorting, you only pass the dividends through. The company sends you the dividend, you send it to the original owner, you could still profit from the drop in share price.
Edit: e.g. EWM (an ETF, I think)
https://uk.finance.yahoo.com/q/hp?s=EWM&d=3&e=4&f=2016&g=d&a...
No, shorting doesn't work that way, obviously. "Shorting" means you sell he stock, so the new owner gets the dividend, not you. That's one reason shorting equities is very risky long-term.
The point I'm making, which I admit is an obvious one, is that without profits a dividend will erode a company's value. Simple flow of money. Unless there's a surplus flow of money in, you can't have an outward flow. Therefore, the effect of a dividend on a company's market cap depends on how much profit they have in comparison.