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 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 >>
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

    How Dividends Work For Investors

    Find out how a company can put its profits directly into your hands.
  3. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  4. 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.
  5. 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.
  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. 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.
  10. Investing

    How And Why Do Companies Pay Dividends?

    If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments ...
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. Dividend Rate

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

    A financial ratio that shows how much a company pays out in dividends ...
  5. Forward Dividend Yield

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

    A dividend payment made in the form of additional shares, rather ...
Hot Definitions
  1. Co-pay

    A type of insurance policy where the insured pays a specified amount of out-of-pocket expenses for health-care services such ...
  2. Protectionism

    Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local ...
  3. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  4. Demonetization

    Demonetization is the act of stripping a currency unit of its status as legal tender and is necessary whenever there is a ...
  5. Investment

    An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic ...
  6. Redlining

    The unethical practice whereby financial institutions make it extremely difficult or impossible for residents of poor inner-city ...
Trading Center