Should I Pay Dividends?

Dividends are included in the calculation of return on investment.

There are two main types of investment: stocks and bonds. Bonds pay the investor in the form of interest and stocks pay the investor in the form of share price appreciation or dividends. Not all companies pay a dividend, however. Ultimately, deciding on whether or not to pay dividends is dependent on the individual goals and objectives of the company.

What Are Dividends

Dividends are a share of corporate profits and are usually promised to shareholders of both common and preferred stock in a company. Many investors, particularly those which are interested in capital preservation, seek out companies that pay a dividend and view the dividend as a source of regular income, much like bond holders look toward interest payments as income. The first step in determining whether or not you should pay dividends is determining what kind of investors you have and want to attract.

Company Goals

Not all companies pay a dividend. Some companies reinvest corporate income back into the company, causing the share price to go up. In this way, investors are awarded through share price appreciation rather than an actual dividend payment. Risk-friendly investors usually prefer the rewards of share price appreciation over dividend payments as dividend payments tend to be low, sometimes as low as just one dollar per year per share.

Board of Directors

The Board of Directors speaks for the shareholder. Their job is to represent the rights of the common and preferred stockholder to management. As such they will also voice any concerns by shareholders and must approve any payment of dividends to the shareholder. As a result, it is best to discuss the payment of dividends with the Board of Directors before making a decision as they may not ratify the dividend payment.

Investor Signals

Understand the signal that not paying a dividend sends to the investment community. This includes both current and prospective shareholders. Certain investors seek out dividend payments as they represent a form of regular income, therefore most companies are hesitant to skip a dividend payment, even in difficult economic times, and will opt to borrow funds to pay the dividend rather than skip the payment. This is also a reason why companies are hesitant to increase the dividend payment from year to year.

References

• New York Life: What Are Dividends?; June 2008
• SEC: Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends; 2004