A:

To understand the differences in volatility commonly seen in the stock market, we first need to take a clear look at exactly what a dividend-paying stock is and is not.

Public companies and their boards typically start issuing regular dividend payments to common shareholders once their companies have reached a significant size and level of stability. Often, young, fast-growing companies prefer not to pay dividends, opting instead to re-invest their retained earnings into their business operations, compounding their growth and thus the book value of their shares over time. However, once a company does decide to start paying a specified amount of money to shareholders in the form of regular cash dividends, its stock usually trades with a little less price volatility in the market. (For further reading, see How And Why Do Companies Pay Dividends?)

There are a couple of key reasons for this, the first being that the regular dividend payments received by the company's shareholders represent consistent cash flows received from their investment in the stock. For example, suppose you were considering investing in two hypothetical widget companies, ABC Corp. and XYZ Inc. Let's say that ABC pays out a regular, quarterly dividend of $0.10 per share, while XYZ never pays out dividends. Both stocks trade at $10 per share. Suppose that whichever stock you choose to invest in, you don't really have a great idea what the share price will be in one year's time. ABC could be trading at $5 and XYZ at $20 or vice versa - you just don't know. However, one thing you do know is that if you invest in ABC Corp., you'll very likely receive $0.40 in cash dividends over the year for each $10 share you purchase today. The same cannot be said about XYZ Inc.; therefore, this makes ABC a little safer.

Second, companies know that the stock market reacts very poorly to stocks that reduce their dividend payments. Thus, once a company begins paying a regular dividend amount, it will generally do everything it reasonably can to continue paying that dividend. This gives investors high confidence that the dividend payments will continue indefinitely at the same amount or greater, and thus the shares of dividend-paying stocks tend to be viewed as quasi-bond instruments: they pay a regular cash flow that is backed by the entire financial strength of the company, but they also allow investors to participate in any share price gains the stock may enjoy.

Given both of these factors, the market tends to be less likely to drive down the share prices of stocks that pay high dividends than those of companies that pay no dividends. This means that stocks that pay sizable, regular dividends usually trade in the market with less volatility than stocks that don't pay dividends. Of course, this is not a hard and fast rule, but on average it holds true.

To learn more, check out The Power Of Dividend Growth, The Importance Of Dividends and How Dividends Work For Investors.

RELATED FAQS
  1. Do penny stocks pay dividends?

    Because of the small market capitalization and revenues typical of most penny stocks, there are very few that offer dividends. ... Read Full Answer >>
  2. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  3. When does the holding period on a stock dividend start?

    The holding period on a stock dividend typically begins the day after it is purchased. Understanding the holding period is ... Read Full Answer >>
  4. What is the average annual dividend yield of companies in the retail sector?

    According to data published by the NYU Leonard N. Stern School of Business, as of January 2015, the average annual dividend ... Read Full Answer >>
  5. What kind of companies in the utilities sector offer the most stable dividends for ...

    Among the companies that offer the most stable dividends for risk-averse investors are large, solidly established U.S.-based ... Read Full Answer >>
  6. What average annual total return does the utilities sector generate?

    Due to their highly stable earnings and cash flows, utilities companies are popular among investors interested in dividend ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Utilities Select Sector SPDR

    Learn about the Utilities Select Sector SPDR ETF and the benchmark index it tracks, and understand what type of investors may be interested in the fund.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares International Select Dividend

    Learn how the iShares International Select Dividend ETF provides investors an opportunity to gain exposure to high-quality companies outside the United States.
  3. Investing Basics

    How Do You Find Penny Stocks That Pay Dividends?

    Learn about how investors can use online stock screeners to obtain a list of dividend-paying penny stocks for their consideration.
  4. Investing News

    Understanding How Mutual Funds Pay Dividends

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
  5. Investing Basics

    Understanding the Modigliani-Miller Theorem

    The Modigliani-Miller (M&M) theorem is used in financial and economic studies to analyze the value of a firm, such as a business or a corporation.
  6. Fundamental Analysis

    Bet on this U.S. Automaker for Long-Term Gains

    Ford holds a stronger technical position than General Motors and also pays a consistent dividend. This combination could mean greater 3-to-5-year returns.
  7. Stock Analysis

    2 Stocks to Bet on the Future of Space Exploration

    Learn about why investors must wait to invest in Space X, and read about other companies involved in the future of space exploration.
  8. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  9. Professionals

    How Does Tim Cook's Management Style Differ from Steve Jobs?

    Understand the differences between Tim Cook and Steve Jobs. Learn if the perceived differences makes Cook a good or bad leader and CEO.
  10. Mutual Funds & ETFs

    What You Need To Know About Bond ETF Yields

    When it comes to fixed income investing, yield is an important component of a bond investment’s total return to accurately assess if it's the right move.
RELATED TERMS
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  4. Dividend Payout Ratio

    The percentage of earnings paid to shareholders in dividends. ...
  5. Record Date

    The cut-off date established by a company in order to determine ...
  6. Dividend

    A distribution of a portion of a company's earnings, decided ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!