Common Stock Dividends
There are 2 ways that investors can earn a profit by buying stock: by buying the stock low and selling it higher, and by receiving dividends. While most companies—especially small, growing companies—do not pay a dividend, most large, profitable companies do by necessity, because there is a limit to how large a company can grow, and so the only way to maintain its stock price is by paying a dividend.
However, there are several advantages to stocks paying a dividend over those that don’t. Dividend-paying stocks provide a more certain income than what price appreciation alone offers. When the stock market declines, holders of dividend-paying stocks still receive an income, and the dividend helps to maintain the stock price even in a down market. And, often, the dividend plus the capital gains of a dividend-paying stock is greater than the capital gains of many stocks that do not pay a dividend. In fact, dividends have accounted for about 40% of the total return of the stock market since 1928!
Should The Company Pay A Dividend?
Whether a dividend will be paid depends on the profitability of the firm. While a firm does not have to earn profits to pay a dividend, it would generally be a bad decision for an unprofitable firm to pay dividends. And without profits, the future payment of a dividend would be in jeopardy.
The board of directors decides if and when a stock dividend will be paid, and how much. The board will generally consider the company’s financial position, both now and in the future, and the opportunity costs of paying a dividend. If the company can use the money to grow faster, then a dividend probably will not be paid. But if a company is both large and profitable, then it could pay some portion of its earnings as a dividend, since it becomes more difficult for a large company to grow ever larger. Hence, without the payment of a dividend, investors will shun the stock, since there is little chance to profit from price appreciation, and the stock’s price will collapse.
Besides size, the largest factor in considering a dividend payment is the company’s common earnings per share (EPS), which is the after-tax income of the company minus the dividends paid to preferred shareholders divided by the number of common shares outstanding.
There are 2 ways that investors can earn a profit by buying stock: by buying the stock low and selling it higher, and by receiving dividends. While most companies—especially small, growing companies—do not pay a dividend, most large, profitable companies do by necessity, because there is a limit to how large a company can grow, and so the only way to maintain its stock price is by paying a dividend.
However, there are several advantages to stocks paying a dividend over those that don’t. Dividend-paying stocks provide a more certain income than what price appreciation alone offers. When the stock market declines, holders of dividend-paying stocks still receive an income, and the dividend helps to maintain the stock price even in a down market. And, often, the dividend plus the capital gains of a dividend-paying stock is greater than the capital gains of many stocks that do not pay a dividend. In fact, dividends have accounted for about 40% of the total return of the stock market since 1928!
Should The Company Pay A Dividend?
Whether a dividend will be paid depends on the profitability of the firm. While a firm does not have to earn profits to pay a dividend, it would generally be a bad decision for an unprofitable firm to pay dividends. And without profits, the future payment of a dividend would be in jeopardy.
The board of directors decides if and when a stock dividend will be paid, and how much. The board will generally consider the company’s financial position, both now and in the future, and the opportunity costs of paying a dividend. If the company can use the money to grow faster, then a dividend probably will not be paid. But if a company is both large and profitable, then it could pay some portion of its earnings as a dividend, since it becomes more difficult for a large company to grow ever larger. Hence, without the payment of a dividend, investors will shun the stock, since there is little chance to profit from price appreciation, and the stock’s price will collapse.
Besides size, the largest factor in considering a dividend payment is the company’s common earnings per share (EPS), which is the after-tax income of the company minus the dividends paid to preferred shareholders divided by the number of common shares outstanding.
Earnings Per Share = (Net Profit – Preferred Dividends) / Number of Outstanding Common Stock Shares
If the common earnings per share is high and likely to remain high, and if the company is too large to grow much larger, then the board of directors will probably decide to pay a dividend.
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