Dividend Cuts
A portion of a company's net profits can be allocated toshareholders asa dividend, or kept within the company asretained earnings.Dividend payments are decided by the board of directorsand must be approved byshareholders.These payments can be issued as cashor as shares of stock.
A dividend cut occurs when a dividend-paying company either completely stops paying out dividends (usually a worst-case scenario) or reduces the amount it pays out. This most often leads to a sharp decline in the company's stock price, because this action is usually a sign of a company's weakening financial position, which makes the company less attractive to investors.
Key Takeaways
- Dividend cuts are most often a negative sign for a company's financial health.
- Companies usually make drastic dividend cuts because of financial challenges like declining earnings or mounting debts.
- Sometimes companies may cut dividend payments for more positive reasons, like preparing for a major acquisition or a stock buyback.
Understanding Why Dividends May Be Drastically Cut
Most Often Bad News
Dividends are usually cut due to factors such as weakening earnings or limited funds available to meet the dividend payment. Typically, dividends are paid out from the company's earnings, andif earnings decline over time, the company either needs to increase its payout rate or access capital from other places, such as its short-term investments or debt, to meet the past dividend levels.
If the company uses money from non-earnings sources or takes up too much of the earnings, it may be putting itself into a compromising financial position. For example, if it has no money to pay off its debts because it is paying out too much in dividends, the company could default on its debts. But usually, it won't come to this, as dividends are usually near the top of the list of things cut when the company is faced with financial challenges.
This is exactly why dividend cuts are seen as a negative. A cut is a sign that the company is no longer able to pay out the same amount of dividends as it did before without creating further financial difficulties.
Not Always Bad News
While most investors rightly consider a drastic dividend cut a negative sign for a company's health, on some occasions, it is not such a harbinger of doom for a company.
Under certain conditions—for example, when the pricing and conditions are just right for a stock buyback; weathering a major recession becomes the priority; or a company needs to accumulate cash on hand for a big merger or acquisition.
In these cases, a dividend cut—even a rather drastic one—may not necessarily be a sign of trouble, or even a sign that selling the stock is your best course of action. Like with any and all financial decisions, doing due diligence and careful research is key to successful investing.
The Bottom Line
Companies that can grow their dividends are seen as stable and attract investors looking for income as well as capital gains. Sometimes, however, it can hurt a company's bottom line to distribute profits as dividends rather than retain earnings to solidify the company's financials. Companies may cut dividends in response to an economic downturn, a spate of negative earnings, or more serious threats to the company's health. Other times, the cut may be more strategic and orient towards future growth or allow for buybacks.
FAQs
Financial Difficulties: Dividends are paid out through a company's profits. If profits or cash flow is insufficient, the company may be forced to cut its dividend. Reinvestment Needs: A company might cut its dividends to create cash flow to support a new project or acquisition or to pay down debt.
Why would a company cut its dividend? ›
Companies may cut dividends in response to an economic downturn, a spate of negative earnings, or more serious threats to the company's health. Other times, the cut may be more strategic and orient towards future growth or allow for buybacks.
Why would a company stop paying dividends? ›
The chief cause of a dividend suspension is the issuing company is under financial strain. Because dividends are issued to shareholders out of a company's retained earnings, a struggling company may choose to suspend dividend payments to safeguard its financial reserves for future expenses.
What causes dividend yield to decrease? ›
The dividend yield is an estimate of the dividend-only return of a stock investment. Assuming the dividend is not raised or lowered, the yield will rise when the price of the stock falls. Conversely, it will fall when the price of the stock rises.
What happens to a company's stock price when dividends are unexpectedly reduced? ›
We can take an example of two scenarios here: Dividend announced is lower than expected: When a company XYZ announces the dividend, which is lower than what was expected, it can cause a drop in the stock price, and even the investors start to speculate the reasons for the same.
What happens to stock prices after a dividend cut? ›
With dividends, the stock price typically undergoes a single adjustment by the amount of the dividend. The stock price drops by the amount of the dividend on the ex-dividend date. Remember, the ex-dividend date is typically the same day as the record date.
What is an example of a dividend cut? ›
For example, consider a $20 stock with an annual payout of $1 (for a dividend yield of five percent) that cuts its dividend by 20 percent to 80 cents. If the stock plummets by 25 percent to $15, the dividend yield — despite the lower dollar amount of the payout — would actually be higher, at 5.33 percent.
What does it mean when a company suspends the dividend? ›
When a company suspends dividend payments, this means that it has canceled the payment it intended to issue to shareholders. This can happen for a period of time or for the foreseeable future, and can disrupt the plans of people who own that company's shares.
Is it good if a company doesn't pay dividends? ›
Companies that offer dividends provide investors with a regular income as the stock price moves up and down in the market. Companies that don't offer dividends are typically reinvesting revenues into the growth of the company itself, which can eventually lead to greater increases in share price and value for investors.
Can a company declare a dividend and not pay it? ›
There is no particular period or limitation under company law during which a dividend should or shouldn't be paid. However, dividends can only be paid when a company has made a profit.
Key Takeaways. Shareholders who sell their stock before the ex-dividend date do not receive a dividend. The ex-dividend date is the first day of trading in which new shareholders don't have rights to the next dividend disbursem*nt. If shareholders continue to hold their stock, they may qualify for the next dividend.
What is a good dividend per share? ›
Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment.
Why do stocks fall after a dividend? ›
After a stock goes ex-dividend, the share price typically drops by the amount of the dividend paid to reflect the fact that new shareholders are not entitled to that payment. Dividends paid out as stock instead of cash can dilute earnings, which can also have a negative impact on share prices in the short term.
Why do companies cut dividends? ›
Large, stable corporations almost never cut dividends as a strategic choice. Instead, they reduce dividends only when they have low earnings or when challenging economic conditions force their hand. CFOs frequently ask whether they should cut dividends to invest in growth.
Can companies stop paying dividends? ›
Companies that choose to pay dividends to shareholders do so quarterly, meaning that executives must have visibility into future cash flows and allocate sufficient capital to cover payments. Cutting or canceling a dividend is often a sign that worries investors and may hurt a company's stock price.
Is it better to receive dividends as cash or shares? ›
Stock dividends are thought to be superior to cash dividends as long as they are not accompanied by a cash option. Companies that pay stock dividends are giving their shareholders the choice of keeping their profit or turning it to cash whenever they so desire; with a cash dividend, no other option is given.
Why are managers reluctant to cut dividends? ›
Part of the reason for "sticky" dividends is that firms are reluctant to cut dividends, because of the fear that markets will punish them. Consequently, they do not increase dividends unless they believe that they can maintain these higher dividends.
When should a company not 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. Mature firms that believe they can increase value by reinvesting their earnings will choose not to pay dividends.
What happens if a company fails to pay dividends? ›
Nothing. A company is not required to pay dividends. It is simply one option open to them for any excess funds they have. If the shareholders (the people who own the company) don't like this they could attempt to remove the directors in order to install someone who would issue dividends.
Why would a company have a low dividend policy? ›
Some companies decide not to pay dividends at all, particularly those in high-growth industries or early-stage startups reinvesting profits to fuel expansion. These companies prioritize reinvestment of earnings into research, development, acquisitions, or debt reduction rather than distributing dividends.
