Dividends affect the price of the underlying stock in three primary ways. While the dividend history of a given stock plays a general role in its popularity, the declaration and payment of dividends also has a specific and predictable effect on market prices.
It stands to reason that the possibility of creating recurring investment income encourages investors to purchase and retain shares of stock. While this motivation may seem to be purely economical, the underlying beliefs about the company's profitability are what impact stock prices the most. To understand how dividends positively affect investor thinking, it helps to first understand the mechanics of the stock market and the basic of how dividends work.