Loading the player...
A:

Dividends are corporate earnings that companies pass on to their shareholders. There are a number of reasons why a corporation might choose to pass some of its earnings on as dividends. There are also a number of reasons why it might prefer to reinvest all of its earnings back into the company.

A company that is still growing rapidly usually won't pay dividends, because it wants to invest as much as possible into further growth. Even a mature firm that believes it will do a better job of increasing its value (and therefore a better job of increasing its share price) by reinvesting its earnings will choose not to pay dividends. Companies that don't pay dividends might use the money to start a new project, acquire new assets, repurchase some of their shares or even buy out another company.

Also, the choice to not pay dividends may be more beneficial to investors from a tax perspective. Dividends are taxable to investors as ordinary income, which means an investor's tax rate on dividends is the same as his marginal tax rate. Marginal tax rates can be as high as 35% (as of 2012). The capital gains on the sale of appreciated stock can have a lower, long-term capital gains tax rate (typically 15% as of 2012) if the investor has held the stock for more than a year.

Firms that choose to reinvest all of their earnings, instead of issuing dividends, may also be thinking about the high potential expense of issuing new stock. To avoid the risk of needing to raise money this way, they choose to keep all of their earnings.

However, for a mature company that doesn't need to reinvest as much in itself, and that has stable earnings, there are several reasons why issuing dividends can be a good idea. Many investors like the steady income associated with dividends, so they will be more likely to buy that company's stock. Investors also see a dividend payment as a sign of a company's strength and a sign that management has positive expectations for future earnings, which again makes the stock more attractive. A greater demand for a company's stock will increase its price.

A company may also choose not to pay dividends because the decision to start paying dividends or to increase an existing dividend payment is a serious one. A company that eliminates or reduces its existing dividend payment may be viewed unfavorably and its stock price may decrease.

RELATED FAQS
  1. If I reinvest my dividends, are they still taxable?

    Take a brief look at how the Internal Revenue Service taxes different kinds of dividends, including taxation on dividends ... Read Answer >>
  2. Can dividends be paid out monthly?

    Find out if stocks can pay dividends monthly, and learn about the types of companies most likely to do so and how monthly ... Read Answer >>
  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: ... Read Answer >>
  4. How do dividends affect retained earnings?

    Find out how distribution of dividends affects a company's retained earnings, including the difference between cash dividends ... Read Answer >>
  5. What is the difference between yield and dividend?

    Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >>
  6. What metrics should I evaluate when looking for high-yielding dividend stocks?

    Evaluate high-yield dividend stocks to determine if they are a good investment to produce steady income. Learn what questions ... Read Answer >>
Related Articles
  1. Investing

    Why Do Some Companies Pay A Dividend, While Other Companies Do Not?

    Rapidly growing companies usually don’t pay dividends. Instead, they reinvest earnings to fund growth and increase their value.
  2. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  3. Retirement

    Reinvesting Dividends Pays in the Long Run

    Find out why dividend reinvestment is one of the easiest ways to grow wealth, including how this tactic can increase your investment income over time.
  4. Financial Advisor

    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

    Don't Take Dividends For Granted

    Companies have been paying dividends to their shareholders since the 1600s and have given investors good reason to hold onto their shares for long time periods. For many investors, dividends ...
  6. Investing

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  7. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  8. Investing

    How Dividend Reinvestment Grows Your Money Faster

    Dividend reinvestment is a smart strategy for growing your investments faster over the long term, but it’s not a get-rich-quick proposition.
  9. Taxes

    3 Tax Implications of Dividend Stocks

    Dividend paying companies are attractive in a low interest rate environment, but income seeking investors have to be careful of the potential tax hit.
RELATED TERMS
  1. Dividend

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

    The policy a company uses to decide how much it will pay out ...
  3. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  4. Stock Dividend

    A dividend payment made in the form of additional shares, rather ...
  5. Cash Dividend

    Money paid to stockholders, normally out of the corporation's ...
  6. Indicated Yield

    The dividend yield that a share of stock would return based on ...
Hot Definitions
  1. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  2. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  3. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the ...
  4. Border Adjustment Tax

    A tax levied on goods based on where they are sold – exported goods are exempt from tax; those imported and sold in the ...
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  6. Blind Trust

    A trust in which the trustees have full discretion over the assets, and the trust beneficiaries have no knowledge of the ...
Trading Center