Dividends are corporate earnings that companies pass on to their shareholders. They can be in the form of cash payments, shares of stock, or other property. Dividends may be issued over various timeframes and payout rates.
There are a number of reasons why a corporation may choose to pass some of its earnings on as dividends, and several other reasons why it might prefer to reinvest all of its earnings back into the company.
- Dividends are corporate earnings that companies pass on to their shareholders.
- Paying dividends sends a message about a company's future prospects and performance.
- Its willingness and ability to pay steady dividends over time provides a solid demonstration of financial strength.
- A company that is still growing rapidly usually won't pay dividends because it wants to invest as much as possible into further growth.
- Mature firms that believe they can increase value by reinvesting their earnings will choose not to pay dividends.
Why Do Some Companies Pay A Dividend, While Other Companies Do Not?
Why Some Companies Choose to Issue Dividends
For a mature company with stable earnings that doesn't need to reinvest as much in itself, here's 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.
One of the simplest ways for companies to foster goodwill among their shareholders, drive demand for the stock, and communicate financial well-being and shareholder value is through paying dividends.
Paying dividends sends a clear, powerful message about a company's future prospects and performance, and its willingness and ability to pay steady dividends over time provides a solid demonstration of financial strength.
Why Some Companies Choose Not to Pay Dividends
Quickly expanding companies typically will not make dividend payments because during pivotal growth stages, it's fiscally shrewder to re-invest the cashback into operations. But even well-established companies often reinvesting their earnings, in order to fund new initiatives, acquire other companies, or pay down debt. All of these activities tend to spike share price.
The choice not to pay dividends may be more beneficial to investors from a tax perspective:
- Non-qualified dividends are taxable to investors as ordinary income, which means an investor's tax rate on dividends is the same as their marginal tax rate.
- Marginal tax rates can be as high as 37%—as of 2020.
- For qualified dividends, the tax rate is either 0%, 15%, or 20%, depending on the marginal income tax bracket that the investor falls under.
- The capital gains on the sale of appreciated stock can have a lower, long-term capital gains tax rate—typically up to 20% as of 2019—if the investor has held the stock for more than a year.
Companies often reinvest earnings in lieu of making dividend payments, in order to avoid the potentially high costs associated with issuing new stock.
The following notable technology companies have historically declined to issue dividends:
The Bottom Line
When a company pays dividends, it returns some of its profits directly to shareholders, sending a signal to the market of stable and reliable operations. Newer companies, or those in the technology space, often opt instead to re-direct profits back into the company for growth and expansion, so they do not pay dividends. Rather, this reinvestment of retained earnings is often reflected in a rising share price and capital gains for investors.