Why would a company make drastic cuts to its dividend payments?

By Chad Langager AAA
A:

A dividend cut occurs when a dividend paying company either completely stops paying out dividends (a worst-case scenario) or reduces the amount it pays out. This will often lead to a sharp decline in the company's stock price, because this is usually a sign of a company's weakening financial position, which generally makes the company less attractive to investors.

Dividends are usually cut due to factors such as weakening earnings or a limited amount of funds available to meet the dividend payment. Typically, dividends are paid out from the company's earnings; if earnings decline over time, the company will either need to increase its payout rate or access capital from other places, such as its short-term investments or debt, to meet the past dividend levels. If the company uses money from non-earnings sources or takes up too much of the earnings, it may be putting itself into a compromising financial position. For example, if it has no money to pay off its debts because it is paying out too much in dividends, the company could default on its debts. But usually, it won't come to this, as dividends are usually near the top of the list of things cut when the company is faced with financial challenges.

This is exactly why dividend cuts are seen as a negative. A cut is a sign that the company is no longer able to pay out the same amount of dividends as it did before without creating further financial difficulties.

For more insight, read The Importance Of Dividends and Is Your Dividend At Risk?

RELATED FAQS

  1. What rights do all common shareholders have?

    Learn what rights all common shareholders have, and understand the remedies that can be taken if those rights are violated ...
  2. How do I find the information needed for input into the Dividend Discount Model (DDM)?

    Learn where analysts and investors can find the three pieces of necessary information that allow them to calculate the dividend ...
  3. Why should a company buy back shares it feels are undervalued instead of redeeming ...

    Discover the difference between common stock and preferred stock. When is repurchase preferable to redemption, and what factors ...
  4. What are the types of share capital?

    Understand the characteristics of common stock and preferred stock, the two ways by which companies obtain share capital ...
RELATED TERMS
  1. Dividend

    A distribution of a portion of a company's earnings, decided ...
  2. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...
  3. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  4. Paid-Up Additional Insurance

    Additional whole life insurance that a policyholder purchases ...
  5. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  6. Sucker Yield

    When an investor has essentially risked all of his capital for ...

You May Also Like

Related Articles
  1. Charts & Patterns

    Are These the Top Dividend Stocks of ...

  2. Options & Futures

    Trade Covered Calls On High Dividend ...

  3. Mutual Funds & ETFs

    Should the YYY ETF Be on Your Radar?

  4. Stock Analysis

    Is This Dividend Stock A Value Or Value ...

  5. Stock Analysis

    Is Intel's Newly Raised Dividend At ...

Trading Center