Common stocks have the option of paying dividends, which are cash payments that distribute some of a company’s profits to its shareholders. Companies can pay dividends only from retained earnings, which are the accumulated profits of a company. Corporations can choose not to pay dividends for several reasons. The meaning of a company’s dividend policy can be positive, neutral or negative, depending on the context.
You might interpret the lack of dividends as a positive indication when the company uses the cash to pursue profitable investments. A corporation grows when it invests in projects that return more than the required internal rate of return on the company’s capital, which is the equity and debt held by the company. Stock of this kind of corporation is called growth stock. Many fast-growing companies pay no dividends.
You might assign a neutral meaning to a no-dividend policy when the company uses the money to improve its financial condition. For example, a company can use extra cash to pay down debt rather than paying dividends. This improves the financial position by reducing its interest expenses and possibly increasing its credit rating. Another neutral alternative use of excess cash is for the corporation to buy back some of its stock shares in the open market. This helps support the stock price without saddling all shareholders with taxable dividends.
It’s a negative when a company skips a scheduled dividend because of a cash crunch. If a company must choose between paying interest due or dividends, it must pay interest or else creditors can force the company into bankruptcy. Cutting or omitting a dividend might indicate a cash shortage that can threaten the ongoing operation of the company. If a company doesn't have enough retained earnings to pay a dividend, it might indicate an inability to generate a profit, which could also lead to bankruptcy.
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