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I don't think there is any doubt that it makes sense to adjust for the
dividend when comparing the price before the dividend to the price after
the dividend.
The more interesting question is the impact of making the adjustment
backwards rather than forwards. Usually, the adjustment is made by
moving the historical prices before the extraordinary dividend down by
the amount of the extraordinary dividend. The further back in history
you go, however, the less meaningful this adjustment becomes.
Part of the reason is the simple effect of present-valuing. $5 today is
the equivalent of less than $5 yesterday, and the further back you go,
the greater the amount of the discount you should be taking. For
example, at a discount rate of 5%, the $5 is worth less than $4 going
back five years.
Another reason, however, is also the distortion the adjustment makes on
the price path of a fast-growing company. Suppose the company priced at
$13 had been growing earnings at 25% a year, and the stock price had
reflected that growth rate. Well, that would mean that, going back five
years, the stock price would have been less than $5. The dividend
adjustment would leave the historical stock price as a negative value!
A better method would be to adjust the current stock price upwards to
account for the present value of the $5, but that would be terribly
inconvenient, so the less useful historical adjustment is used, despite
the distortions on long term charts.
Regards
DanG
Michael S. wrote:
>This has probably come up before, but here is a recent case:
>
>In mid-August of 2004, Blockbuster Inc (BBI), then trading around $13, paid out a cash dividend of $5 (almost half the value of a share!) to shareholders. Of course, the stock price dropped by an equal amount to about $8.
>
>Peter Worden of TC2000 subsequently adjusted his BBI charts. He writes, "For shareholders of record this entire transaction was obviously a wash. However, for anyone looking at an unadjusted price chart the result was a big downside gap - a drop in price which negatively impacted the technical indicators - a drop in price which obviously did not accurately reflect a true change in the value of the stock. For this reason, we have now adjusted the historical data for BBI, just as we would have done in the case of a stock split."
>
>The problem does not end here, though. For those who had been holding the stock at the time, the transaction was indeed a zero-sum game. New buyers coming in after the dividend payout, however, did receive shares whose intrinsic as well as extrinsic value was definitely $5 less than the day before.
>
>So TC2000 adjusted their charts so as to keep indicators undisturbed. So did Quotes-Plus. Other vendors such as Quote.com kept the gap the way it had manifested that day. It seems to me that both points of view have some value. What do listers think?
>
>Best regards,
>Michael Suesserott
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>Yahoo! Groups Links
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