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 is the difference between preferred stock and common stock?

    Preferred and common stocks are different in two key aspects. First, preferred stockholders have a greater claim to a company's ...
  2. Why do some preferred stocks have a higher yield than common stocks?

    Before we answer this question, let's just take a quick review of what a stock's yield is actually measuring.The yield is ...
  3. Which is better a cash dividend or a stock dividend?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ...
  4. What happens during the spending/gifting phase of an investor's life cycle?

    The final phase(s) in an investor's life cycle is the spending/gifting phase, during which wealth accumulated over many years ...
RELATED TERMS
  1. Payout Ratio

    The proportion of earnings paid out as dividends to shareholders, ...
  2. Retention Ratio

    The proportion of earnings kept back in the business as retained ...
  3. S&P 500 Dividend Aristocrats

    Companies that have had an increase in dividends for 25 consecutive ...
  4. UPREIT

    Short for umbrella partnership real estate investment trust, ...
  5. DownREIT

    A joint venture between a real estate owner and a real estate ...
  6. Current Dividend Preference

    A safety feature of preferred shares, whereby holders of such ...
comments powered by Disqus
Related Articles
  1. How Warren Buffett made Berkshire Hathaway ...
    Stock Analysis

    How Warren Buffett made Berkshire Hathaway ...

  2. Digging Into The Dividend Discount Model
    Markets

    Digging Into The Dividend Discount Model

  3. The Power Of Dividend Growth
    Investing Basics

    The Power Of Dividend Growth

  4. Dissecting Declarations, Ex-Dividends ...
    Investing Basics

    Dissecting Declarations, Ex-Dividends ...

  5. The Perks Of Dividend Reinvestment Plans
    Fundamental Analysis

    The Perks Of Dividend Reinvestment Plans

Trading Center