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 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 Do Some Companies Pay A Dividend, While Other Companies Do Not?
Why Some Companies Choose Not to Pay Dividends
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 may use the money to start a new project, acquire new assets, repurchase some of their shares, or even buy out another company.
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 2019.
- 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.
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.
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.