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. How and when are stock dividends paid out?

    Learn about why, when and how companies declare and issue dividend payments to common stock shareholders. Also learn the ...
  2. What is private wealth management?

    Understand what private wealth management is from the perspective of both the private client as well as the private wealth ...
  3. What are some examples of a deferred tax liability?

    Learn why deferred tax liability exists, with specific examples that illustrate how it arises as a result of temporary differences.
  4. What dividend yield is typical for companies in the industrial sector?

    Find out more about dividend yields, what the dividend yield measures and what level of dividend yield is typical for companies ...
RELATED TERMS
  1. Convention Statement

    A document filed by an insurance or reinsurance company that ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative ...
  4. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...
  5. Earned Premium

    The amount of total premiums collected by an insurance company ...
  6. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...

You May Also Like

Related Articles
  1. Investing Basics

    How and when are stock dividends paid ...

  2. Active Trading Fundamentals

    Which oil and gas stocks pay the highest ...

  3. Mutual Funds & ETFs

    What are some popular ETFs that track ...

  4. Investing Basics

    Which insurance companies pay the highest ...

  5. Mutual Funds & ETFs

    5 Dividend ETFs with Growth Potential

Trading Center