How does a dividend work?

What you underwent is normal in Full form efficient markets like the United States. What it means is when you sell the buyer cannot expect to get the dividend which left him or will live him if he buys after the dividend is paid. This happens during the dividend announcement times. So the dividend amount is lost on the price of the stock. In olden days Company Treassures used to do something called 'dividend capture'. They stopped this practice after the Black Monday of 1987 since they used to do it using Index options or sometimes direct. When program trading was discontinued then this also went along with it. If someone used to do it directly with stocks then they will loose on the price in the short run after the dividend got registered.

Dividend is an ethical policy tool of transparent companies. It can be abstractly looked as the standard deviation of the Return on Investment for the past 15 years. Comapnies are bound by ethics and by welfare economic directives to pay (this standard deviation percentage as) dividend. Then ofcourse some companies pay off part of their earnings that is not required for future or next years use. Well palnned compnies make it a point to include dividend policy in their plans.

The value of stock should drop by the value of the dividend.

When you invest in a company you give them money to be capital in return for a share of the company. If the value of the company appreciates then your share is worth more for the same capital. The amount it is worth more is your profit.

This profit is not "realized" until you sell. It's just paper profits. When you are given a dividend it's a bit of cash that they give back because they don't need so much capital at that moment.

The public at large is going to know the company has given back that cash so it is worth that much less (to oversimplify things here).

If you, as an investor, think the company is going to grow some more then by all means ply the dividend back into buying more stock in the same company.

If the 'shares' are in a mutual fund, then once a dividend is paid out, the funds available to the fund are reduced to that extent. The fund also may have to sell a few of its investments to pay the cash dividend. Hence the balance money/investment available to the fund for future gains is reduced, and this is reflected in the lower value of the 'share' after dividend is paid out.

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