Discussing the article: "Market Reactions and Trading Strategies in Response to Dividend Announcements: Evaluating the Efficient Market Hypothesis in Stock Trading"
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Check out the new article: Market Reactions and Trading Strategies in Response to Dividend Announcements: Evaluating the Efficient Market Hypothesis in Stock Trading.
In this article, we will analyse the impact of dividend announcements on stock market returns and see how investors can earn more returns than those offered by the market when they expect a company to announce dividends. In doing so, we will also check the validity of the Efficient Market Hypothesis in the context of the Indian Stock Market.
From time to time, the stock market experiences dramatic price changes. This volatility in the price of stocks incorporates many factors which can majorly be grouped into macro factors and micro factors. Macro factors mainly takes into consideration the events that are economy wide and affects decision making, like change in oil prices, changes in tax policy by government, Monetary Policy, Exchange rate changes, political unrest and wars. In addition to these, Micro factors are the ones which are company specific and determines the movement in price of stock due to more investment or acquisitions, better sales to total asset ratio, and prominently, the dividend policy of the firm.
Dividend is a type of Free Cash Flow (FCF) from the company. FCF is an important indicator looked after by investors while making investment decisions. Dividend Signaling theory throws light on the fact that the announcement of dividend by the company is an indicator of the future growth prospects of the company. And as the future growth prospect becomes clear, ceteris paribus, the stock price of the firm is expected to grow. But there have been unusual citing in the history and some research studies also contradicts this view. IDFC Ltd. announced an interim dividend on 14 February, 2023 and saw a massive fall of 14 percent in their stock price. The major reason cited by investors was that the firm did not find an investment opportunity and hence its future profitability is bleak. Similarly, Thaler, R. H. et.al (2005) shows that dividend changes are negatively correlated with future profitability. In light of this finding, it is important to observe how well the markets react to announcements or changes in dividend policy by the firm.
Efficient Market Hypothesis (EMH) states that share price imbed in itself all market information and hence there is no scope for investors to make any benefit by purchasing an undervalued asset and reselling it at a higher price. But there are nearly 4.8 million active traders in the stock market, which hints at the fact that there is still scope to make profit by trading in the stock market. Modern Portfolio theory sheds light on the fact that markets aren’t fully efficient. Researchers have also come out with the view that the Efficient Market Hypothesis doesn’t hold in every scenario and Behavioral choices are coming into play. Therefore, new variants of EMH have been introduced into the vocabulary.
Author: Kailash Bai Mina