💵 Dividends, splits and buybacks: how companies hand back cash and reshape shares

🎯 In 30 seconds: Companies return cash to shareholders in two main ways: dividends (cash paid per share) and buybacks (the company buys its own shares, so each remaining share owns more). To get a dividend you must own the stock before the ex-dividend date, and on that date the price usually drops by about the dividend, so there is no free money. A very high yield is often a warning, not a bargain. Stock splits change the number of shares and the price per share but not the value of what you own. Reverse splits often signal a struggling company. Buybacks can raise earnings per share without any growth in profit, so always check the share count.

What a dividend is

A dividend is a cash payment from a company to its shareholders, usually from profits. The board of directors decides whether to pay one and how much. Nothing obliges a company to pay a dividend, and a dividend can be cut or stopped at any time.

Many established US companies pay a regular dividend every quarter. Some pay a one-off special dividend when they have extra cash. Many fast-growing companies pay nothing and reinvest every dollar into the business.

If you own 200 shares and the company pays $0.40 per share, you receive $80. In a taxable account, dividends are taxable income for the year you receive them. Taxes for traders covers how.

The four dates that decide who gets paid

• Declaration date: the day the board announces the dividend, its amount and the other dates.
• Record date: the company pays everyone who is on its books as a shareholder on this date.
• Ex-dividend date (ex-date): the first day the stock trades without the right to the next dividend. Buy on or after this date and the seller gets the dividend, not you.
• Payable date: the day the cash is actually paid.

Why are the ex-date and record date the same? Because of settlement, the official transfer of shares after a trade. Since May 28, 2024, most US stock trades settle one business day after the trade date (T+1). A purchase on Friday, March 13 settles on Monday, March 16, just in time to be on the books for the record date. A purchase on Monday, March 16 settles on Tuesday, too late. So the ex-date is set on the record date.

Two special cases from Investor.gov's guidance. If the record date falls on a weekend or holiday, the ex-date is the business day before it. And if a dividend is 25% or more of the stock's value, the ex-date is deferred until one business day after the dividend is paid.

See Market hours and settlement for more on T+1.

Why the price drops on the ex-date

On the ex-date, a buyer no longer gets the upcoming dividend, so the stock is worth that much less to them. All else equal, the price drops by about the dividend amount at the open. Investor.gov notes that with a significant dividend, the stock price may fall by that amount on the ex-dividend date.

Your total wealth did not change. Part of the share's value turned into cash. In a taxable account, you now also owe tax on that $0.50. This is why "buy the day before the ex-date, collect the dividend, sell the next day" is not free money. Real prices move for many other reasons, so the drop is rarely exact, but on average the market prices it in.

It is also why long-term charts use adjusted prices, as explained in Chart basics.

Dividend yield, payout ratio and yield traps

Dividend yield = annual dividend per share / share price. A $40 stock paying $1.60 a year yields 4%.

Payout ratio = dividends per share / earnings per share. If that company earns $2.00 per share, the payout ratio is $1.60 / $2.00 = 80%. It is keeping only 20% of profits to reinvest or cushion bad years. A payout ratio above 100% means the company is paying out more than it earns, which cannot last unless earnings recover.

A yield trap is a stock whose yield looks high because the price has fallen, often for a good reason. A worked example with a hypothetical company:

An investor who bought at $20 for the 8% yield ends up with a 20% loss on price and half the expected income. The trailing yield described the past, not the future.

Stock splits

In a stock split, a company divides each existing share into more shares. In a 2-for-1 split, each share becomes two and the price halves. In a 4-for-1 split, each share becomes four and the price falls to a quarter.

Nothing about the business changes. The company's market cap is the same immediately after the split. Companies usually split after a long rise to bring the share price down to a level that feels easier to buy. With fractional shares now common at many brokers, the practical effect is smaller than it used to be.

Splits matter for traders in practical ways. Historical prices on charts are adjusted. Options contracts are adjusted. Your cost basis per share changes: if you paid $80 a share for 100 shares, after a 2-for-1 split you own 200 shares at a $40 basis each. Your broker should handle this automatically, but check.

Reverse splits

A reverse split combines shares. In a 1-for-10 reverse split, every ten shares become one, and the price per share rises tenfold. 1,000 shares at $0.80 become 100 shares at $8.00.

According to Investor.gov, companies often do this when the share price has fallen so low that it may not attract buyers, or to regain compliance with an exchange's minimum bid price requirement. Some reverse splits cash out holders of fractional shares. Investor.gov also notes investors can lose money from price swings after a reverse split.

A reverse split does not fix whatever drove the price down in the first place. Traders treat a string of reverse splits, especially alongside new share issuance, as a red flag. See Scams and red flags.

Buybacks

In a buyback (share repurchase), a company uses cash to buy its own shares, usually in the open market. Those shares are retired or held by the company, so fewer shares are outstanding. Each remaining share owns a slightly larger slice of the business.

A buyback lifts earnings per share even when total profit does not change:

That 5.3% EPS "growth" came from a smaller share count, not a bigger business. When you see EPS growth in an earnings report, compare it with net income growth to see how much came from buybacks. See Earnings season.

Things to know about buybacks:

• An authorization is not a purchase. A company announcing a "$5 billion buyback program" has given itself permission to buy. It may buy less, slowly, or not at all.
• Price matters. Buying back shares at a high price can destroy value, just as overpaying for anything does.
• Dilution can cancel it out. Many companies pay employees in stock, which adds shares. A company can spend billions on buybacks and still see its share count stay flat. The net change in shares outstanding is what counts.
• There is a tax. Since 2023, certain publicly traded corporations owe a 1% federal excise tax on the fair market value of stock they repurchase, under section 4501 of the tax code, reported on IRS Form 7208.

Dividends versus buybacks: both return cash. Dividends put cash in your hand (and create a tax bill in a taxable account). Buybacks raise the value of each share instead, and you only pay tax when you sell.

Try it

Open the dividend strategy page and pick two dividend-paying stocks. For each, find the latest declared dividend, its ex-date and payable date, then calculate the yield and payout ratio yourself. Add both to your Watchlist and watch the open on the next ex-date: did the price open lower by roughly the dividend? Finally, look up whether either company has split or done a buyback in the past five years, and whether its share count actually fell.

Sources

• Investor.gov (SEC): Ex-dividend dates: when are you entitled to stock and cash dividends
• Investor.gov (SEC): New T+1 settlement cycle, what investors need to know
• Investor.gov (SEC): Reverse stock splits
• IRS: Instructions for Form 7208, excise tax on repurchase of corporate stock