Dividends offer a way to reward shareholders for owning the stock by sharing some of the company profits. Otherwise, the only way to enjoy the fruits of a good investment is to sell it. Because the dividend directly lowers the price of the stock, you can't make money by simply buying the shares right before the dividend payment, receiving the dividend and then selling your shares.
When a company pays a cash dividend, it's paying out money from its coffers to its shareholders based on the number of shares each person owns. For example, say a company has 1 million shares and pays a 50-cent dividend per share. That means that the company is paying out $500,000 to shareholders and can't use that half a million dollars for other purposes.
Paying out cash to the shareholders means that the company isn't worth quite as much as it was before, which lowers the price investors are willing to pay for the stock. For example, for a company worth $22 million and 1 million shares outstanding, each share is worth $22. However, if the company gives $500,000 to investors in a dividend, the company is worth only $21.5 million after the payout. So the price of the stock would drop to $21.50 per share.
No Net Change
Though the price of the shares drops after the dividend, you'll be in the same position financially as you were before the dividend, just in a slightly different form. Assume that the stock is worth $22 before the dividend and is worth $21.50 after paying a 50-cent dividend. If you own 100 shares, before the dividend your shares are worth $2,200 and you have no cash. After the dividend, the shares are only worth $2,150 but you have $50 in cash, bringing your total to $2,200 -- exactly what it was before the dividend.
The drop in the stock's price due to the dividend occurs after the ex-dividend date -- not the announcement date or the actual payment date. That's the last day that you can buy the stock and still be paid the dividend. When the company announces the dividend, it's still possible to buy the stock and receive the dividend so the price doesn't go down.
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