Dividends are corporate profits distributed to shareholders. Dividends are important because they are cash in investors’ pockets and reflect a company’s profitability and financial condition, which influence a stock’s price. Changes in dividends therefore often affect stock prices.
A dividend increase typically results from higher earnings -- both of which are good news to investors. Investor willingness to pay more for a higher dividend and higher earnings will generally lead to an increase in a stock’s price.
Conversely, a dividend reduction means less cash in investors’ pockets and may be a sign of falling profits or other financial difficulties. Investor concerns can send a stock price down.
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Stock prices anticipate, or discount, future events, including dividend payments. By the time a dividend is declared, it has already been priced into the stock. But the stock price can move up or down on a dividend announcement if the dividend amount is more or less than expected.
Dividend Suspension or Elimination
Logically, dividend suspension or elimination should send a stock price down, but in reality the opposite might happen. Dividend suspension or elimination is a drastic step to conserve cash and is often taken to save a failing company from financial ruin. It usually comes after a period of falling earnings or mounting losses and a series of dividend cuts, which cause a major stock price decline. When a dividend is finally suspended or eliminated, speculators may decide that the worst is over and things can only get better. So they start buying the stock, pushing up the price.
Dividend resumption is often a confirmation that the worst is over and that a company has turned the corner and is on its way to financial recovery. Resumed investor buying may push up the stock price.
A company may decide to initiate a dividend when it no longer needs all the cash it is generating. Growth companies usually reinvest all the profits in the business to continue to grow. When a company generates more cash than it needs and decides to pay some of it as dividends, investors may interpret this as a sign of slowing growth (the company is still profitable but does not have much room left for growth) and start selling the stock, pushing the price down.
- “PassTrak Series 7: General Securities Representative License Exam”; Dearborn Financial Services; 2003
- “One Up on Wall Street”; Peter Lynch; 2000