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. 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 >>
  2. What are the dividend reinvestment options for a mutual fund?

    Learn about the options that shareholders have for dividend distributions made by mutual funds and why a shareholder may ... Read Answer >>
  3. 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 >>
  4. What types of companies offer the most dividends?

    Find out which types of companies tend to offer the most dividends, and learn why dividends must be considered carefully ... Read Answer >>
  5. 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 >>
  6. How are dividends usually paid out?

    Discover the two compensation methods commonly used by companies and mutual funds to make dividend payments on equity investments. Read Answer >>
Related Articles
  1. Investing

    How Dividends Work For Investors

    Find out how a company can put its profits directly into your hands.
  2. 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.
  3. 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.
  4. 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 ...
  5. Financial Advisor

    How to Plan for Taxes on Dividends

    Dividends are taxed differently than other investment income. Here are some strategies to help lower taxes on dividends.
  6. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  7. 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.
RELATED TERMS
  1. Dividend

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

    The total expected dividend payments from an investment, fund ...
  3. Dividend Yield

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

    Special dividends paid by a company ahead of an imminent change ...
  5. Stock Dividend

    A dividend payment made in the form of additional shares, rather ...
  6. Capital Dividend

    A type of payment by a firm to its investors that is drawn from ...
Hot Definitions
  1. Straddle

    An options strategy in which the investor holds a position in both a call and put with the same strike price and expiration ...
  2. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  3. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that eventually eliminated tariffs to encourage economic activity between the United ...
  4. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  5. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  6. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
Trading Center