Publicly traded companies often share a portion of their earnings with investors in the form of dividends. These payments are not guaranteed, and may be suspended or modified prior to the dividend's date of record. The company must publicly announce its plans to suspend or resume dividends. Investors who rely on dividend income should diversify their portfolios. This minimizes the impact of any one company suspending or reducing its dividend payments.
Shares of common and preferred stock typically offer the right to receive dividends when the company posts earnings. If the company is struggling and needs to hold onto its cash, it may decide to temporarily stop, or suspend, dividend payments. This decision must be weighed carefully, because it is an indication of financial trouble and may scare off potential investors. Current shareholders may sell their shares because the dividend income no longer meets their needs.
Suspending dividends allows the company to preserve cash when capital markets are weak and it is difficult to obtain new funding. The company can resume dividend payments when economic conditions improve. A company may also suspend dividends when dealing with extenuating circumstances (such as when British Petroleum dealt with the Gulf oil spill of 2010), or when it is the process of changing its core business strategy.
Shares of preferred stock have top priority for dividend payments. The company must have enough money to cover the preferred dividend payments before it may pay any dividends on common stock. Cumulative preferred stock requires the company to make up for any previously suspended preferred dividends before paying common stockholders. Participating preferred shares offer a higher dividend rate for years in which the company posts higher than expected earnings. If the company has suspended its dividends for one of the affected years, it must pay the increased rate to preferred shareholders when resuming payment.
Watch companies that have suspended dividends and are close to recovering financially. You may be able to find an undervalued stock while investor confidence is still low. Once dividends are reinstated, you get income along with appreciation in value as investors return. Make sure the company you choose is projected to remain stable in the future. Companies going through temporary issues such as reorganizations or launching new products are usually a better investment than companies with ongoing cash flow problems.
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