Understanding Cum Dividend: Meaning, Mechanism, and Examples

What Is Cum Dividend?

The term cum dividend means buying a stock with the right to receive the upcoming dividend. This is opposed to ex-dividend, where new buyers are no longer eligible for the dividend. Record dates determine who qualifies for the payout, and stocks often trade slightly higher during the cum dividend period. So, if you buy shares before the ex-dividend date, you’ll receive the dividend, but if you buy after that date, the seller keeps it.

Understanding the Mechanism of Cum Dividend

Before the announcement of year-end results for companies, dates are set out for closing the register for dividend payments and scrips. These dates will determine the qualification for dividends and scrips. A scrip is a document acknowledging a debt. Companies short on cash often pay scrip dividends instead of cash dividends.

Cum dividend is the status of a security when a company is preparing to pay out a dividend at a later date. The seller of a stock cum dividend is selling the right to the share and the right to the next dividend distribution. This situation often results from the timing of the sale rather than the preference of the seller.

In order to buy a share cum dividend, the buyer must complete the purchase before a certain point in the dividend period, called the record date. Companies often require completing the sale two business days before the period ends. Some companies, however, may extend the deadline to the last day of the period. If the buyer completes the recording of the transaction in time, they will receive the eventual distribution. If the buyer misses the deadline, then the share is sold ex-dividend, or without the right to the next distribution. The dates are set based on the declaration date and recording date chosen by the company that issues the stock.

There's no specific schedule for dividend payments, and the dates can vary by company. Some companies pay quarterly dividends, while others pay only once or twice a year. Although uncommon, some companies pay monthly dividends.

Important Considerations for Cum Dividends

Declared Dividends

Cum dividend rights cover the next declared dividend. A declared dividend is an amount approved by the board for payment. Once declared, dividends act as company liabilities. Since dividends are part of a company's profits, the amounts can vary.

A company declares the dividend on the declaration date. Next, a recording date is set for the buyer to qualify for the dividend transfer. Often, a buyer must purchase a share at least two business days before the recording date to get the dividend. This cutoff date is the ex-dividend date or ex-date. If a buyer purchases a share after the ex-date, the seller sells it ex-dividend instead of cum dividend. In this case, the buyer would get the stock but would not be entitled to the distribution.

Dividend Rights and Purchase Price

The price of the stock will adjust depending on if it is cum dividend or ex-dividend. Since information on dividends is publicly available, it is incorporated into the share price under the efficient market hypothesis. Buying just before the deadline to collect dividends and sell stock afterward is too simplistic to work.

Practical Example of a Cum Dividend Scenario

Let's say an investor owns 100 shares of ecommerce firm PricedToSell, and the company's board of directors has declared a quarterly dividend of $0.10 per share. The ex-dividend date is ten days away. The investor is considering selling their shares to finance another purchase. If they sell cum dividend, the buyer would receive the 100 shares at the current price and would be entitled to the $10 in dividend payouts.

Suppose the seller holds off on selling during the cum dividend period, waiting to see if other investments pan out. Those investments don't end up panning out, and the seller is forced to sell the 100 shares of PricedToSell. However, the cum dividend date has passed, and the shares are ex-dividend. To reflect the loss of the dividend, the market price of the shares will be $10 lower, all other things being equal. While the buyer won't receive that quarter's distribution, they will be entitled to future distributions if they continue to hold the shares.