You might say dividends are the statement accessories of the investment world.Just as an impeccably tailored pocket scarf or designer watch says something about the wearer, regular dividend payments make a statement about the issuing company; “well-established,”“secure,”“reliable,” and“profitable” are some of the perceptions that come readily to mind.
In fact, it is the larger and more firmly established companies, the ones with predictable profits, that tend to regularly distribute a portion of their earnings to shareholders,with start-up firms and those on a high-growth trajectory less likely to offer regular dividends.Even well-established companies might choose to reinvest earnings to acquire other firms, pay down debt, or begin new projects. When a dividend distribution is made, it might come from the corporation’s current earnings, or might be taken out of accumulated profits. In either case, the “statement” is—“We’re doing OK.”
And, just as statement jewelry or accessories convey a message about the wearer, companies use the medium of dividends to convey messages about themselves. When a dividend is declared, that is likely to be interpreted by investors as a sign the company is continuing to do well and is generating profits. A company’s long history of regular dividend payments shouts stability and reliability. Investors often interpret dividend payments as a sign that management has positive expectations for the future.
Balancing the interests of the company with those of investors
Just as it would be a mistake to assume that everynattily attired executive cares more about appearance than accomplishment, it would be a mistake to assume that dividend-paying companies are uninterested in growth. The portion of profits that is retained by the corporation is often used to undertake new projects or to acquire new assets.
Investors, for their part, are interested not only in receiving reliable income, but in the growth of the dividend payout itself. While attracted to stocks with high dividends yields, investors are also interested in whether the size of the dividend itself has been increasing.An increase in dividend payout makes a powerful statement, implying an increase in the company’s net profits. But even investors whose primary need is for regular income are likely to welcome news of company growth, which can translate into growth of their own invested capital!
Can “statement pieces” be misleading? Certainly. Just as maintaining a healthy budget means avoiding overspending on fashion accessories, investment analysts examine whether there is a healthy balance between dividend payouts and retained earnings. The dividend payout ratio is a way to evaluate a company’s future prospects. Astute investors understand that extravagant payouts threaten the stability of the company’s finances going forward, paying attention to how much of a company’s net earnings are paid out as dividends.
Dividend mutual funds
Investors seeking reliable income often own shares in dividend-paying stocks through dividend mutual funds. Each individual company whose shares are held by the fund pays its dividend to the fund, which then passes that on to investors through a fund dividend. The fund management adds up all the income received in the portfolio and subtracts fund expenses; the result is divided by the number of fund shares each investor owns. Some funds make monthly dividend distributions, others distribute their dividends quarterly or even annually. Investors have the option of taking those distributions in cash or reinvesting them in fund shares.
Dividends and market prices
Just as fashion statements can affect a person’s acceptance into elite groups, dividend histories make statements that affect stock market prices. Consistent payment of dividends makes a stock attractive to investors, and the stock price often increases as a result. Conversely, when a company reduces, or even ceases to pay a dividend, the market’s perception of that stock—and along with that, the stock price—can take a drop. Learn more about the Sheaff Brock dividend income strategy.
Dividend income stocks are truly the “statement pieces” of the investment world!