Incremental Dividend

What is an Incremental Dividend?

An incremental dividend is a series of repeated increases in the dividend a company pays on its common shares. Larger companies with significant cash flow tend to pay incremental dividends as a way to return value to shareholders. Regularly increasing the dividend is also a signal to investors that the company is doing well.

Sometimes, corporate management teams communicate their plans to pay incremental dividends to help attract income-seeking investors. Other times, management teams won’t communicate an incremental dividend explicitly, but investors pick up on the pattern of rising dividends over a certain period of time.

How the Incremental Dividend Works

An incremental dividend is generally only paid by mature companies, and firms with low dividend payout ratios, that have the cash and earnings to easily increase the dividend amount over time. Shareholders tend to watch this ratio closely, as it helps to indicate a company’s ability to boost dividends in the future.

A company with a high dividend payout already—meaning current dividends represent most of their profits—have little ability to boost the dividend payout unless profits/earnings improve. On the other hand, a company that pays out on a small portion of their profits in dividends has more room to increase their dividend without negatively affecting cash flow.

Incremental dividends are usually viewed positively by the markets. However, there are times when a company’s earnings are not growing, or shrinking, and a company continues to pay incremental dividends. In these situations, shareholders may worry that profits won’t be sustainable over time, and neither will the incremental dividend. When a company pays dividends it can't afford, investors may view this as a negative since it hurts the company's long-term viability.

Types of Dividends

Many firms pay dividends to shareholders in cash, although some pay in additional shares of stock. The former is generally seen more favorably by investors.

The reason is, stock dividends increase a company’s shares outstanding, and, by doing so, they dilute the value of the shares an investor already holds.

For example, say a company with two million shares outstanding declares a cash dividend of $0.50 per share. An investor holding 100 shares receives $50 ($0.50 x 100 shares). Instead of pocketing that dividend, some investors reinvest it by buying additional shares. Reinvesting dividends typically adds meaningfully to gains an investor might receive from just price appreciation over the long term.

However, say the same investor receives a 5% stock dividend. This means the investor receives 5 additional shares (5% of 100 shares). However, to offer this dividend, the company increases its shares outstanding by 100,000 shares (2,000,000 x 1.05). Because the company now has more shares outstanding that are backed by the same company assets, the value of the existing shares in circulation decreases.

When an Incremental Dividend Ends

When a company that pays incremental dividends stops paying them, even once, it’s sometimes negative for the stock price. The reason is, companies that pay incremental dividends tend to attract a high percentage of income-seeking investors.

When a company that has regularly increased their dividend all of a sudden stops, that sends a signal to investors that the company is no longer growing or can no longer afford to keep increasing the dividend. Investors may jump ship, taking this is a negative, and reinvest those funds in another stock that is still regularly increasing its dividend.

Real-Word Example of an Incremental Dividend

Target Corporation (TGT) is an example of a company with steady growth in its dividend. Going back to 1972 Target has increased the dividend amount every year.

The dividend started out at $0.0021 per quarter in the last quarter of 1967 and all of 1968.

1969, 1970, and 1971 saw an increase to $0.0026 per quarter.

From 1972 onward, the dividend payout has increased every single year up through 2019. In 2020 the company paid out $2.68 in dividends for the year, an average of $0.67 per quarter.