Companies pay out dividends to share their profits with investors. Factors in deciding whether to do so include company profitability, capital needs, stock price trends and investor expectations. A company must act in the best interest of its shareholders, so in making dividend decisions it considers the impact on the business, the share price and shareholder value.
Factors affecting whether a company will pay dividends include the company's profitability, capital needs, investor expectations and effects on stock prices and shareholder value.
The single biggest dividend payment factor is profitability: a company must be profitable to be able to pay dividends. The more profit a company generates, the more it can afford to pay out in dividends. If a company is experiencing financial difficulties, such as falling sales or soaring costs that lead to losses, it simply can’t afford to pay dividends. Mounting losses can jeopardize a company’s very existence. To survive, the company may cut the dividend to conserve cash.
A company can use corporate profits in a variety of ways. It can reinvest profits back into the business to expand, acquire another business or buy back its own stock to boost the stock price. Addressing all those needs is a balancing act. The company's overall capital needs determines how much of the profit to pay out in dividends and how much to retain for other corporate needs.
Companies know their investor bases – the shareholders who own the stock for specific reasons. Conservative, income-oriented investors buy stocks that pay generous dividends and increase them over time. Companies try to maintain predictable dividend policies to keep shareholders happy because stock selling by disgruntled shareholders may send the stock price down. In a bad quarter, some companies may even defer operating expenses or borrow money to maintain the dividend at the current level.
A company must make sure the dividend is sufficient to keep investors happy, but not too excessive, so that it can continue to pay it the future. The ratio of current profits to current dividend is called the dividend coverage. The opposite ratio, of current dividends to current profits, is called the dividend payout ratio.
A dividend increase can cause a stock price to go up by making it more valuable to investors, who are willing to pay more for it. A dividend decrease can cause a stock price to go down because the stock becomes less valuable to investors, or because the decrease is a sign of falling profits or other financial difficulties. A dividend increase often affects a stock price more than the actual dividend amount. Knowing that, a company may pay small dividends but increase them periodically to boost the stock price.
Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.