Dividends are corporate earnings that companies pass on to their shareholders. They can be in the form of cash payments, stocks, or other property. Dividends can be issued over various time periods and pay rates.
There are a number of reasons why a corporation may choose to transfer part of its earnings as dividends, and several other reasons why it might prefer to reinvest all of its earnings in the company.
- Dividends are corporate earnings that companies pass on to their shareholders.
- Paying dividends sends a message about a company’s future prospects and performance.
- Your willingness and ability to pay consistent dividends over time provides a solid demonstration of financial strength.
- A company that is still growing rapidly does not usually pay dividends because it wants to invest as much as possible in further growth.
- Mature companies that believe they can increase value by reinvesting their earnings will choose not to pay dividends.
Why do some companies pay dividends and others don’t?
Why some companies choose to issue dividends
For a mature company with stable earnings that doesn’t need to reinvest as much in itself, this is why issuing dividends may be a good idea:
- Many investors like the steady income associated with dividends, so they are more likely to buy the shares of that company.
- Investors also view the payment of a dividend as a sign of a company’s strength and a sign that management has positive expectations for future earnings, again making stocks more attractive. A higher demand for a company’s shares will increase its price.
Dividend-paying companies include Apple (AAPL), Microsoft (MSFT), Exxon Mobil (XOM), Wells Fargo (WFC), and Verizon (VZ).
One of the simplest ways for companies to foster goodwill among their shareholders, drive demand for shares, and communicate financial well-being and shareholder value is by paying dividends.
Paying dividends sends a clear and powerful message about a company’s future prospects and performance, and your willingness and ability to pay consistent dividends over time provides a solid demonstration of financial strength.
Why some companies choose not to pay dividends
Typically, rapidly expanding companies will not pay dividends because during critical growth stages, it is more tax-savvy to reinvest cashback in operations. But even well-established companies often reinvest their profits to finance new ventures, acquire other companies, or pay off debts. All of these activities tend to skyrocket the stock price.
The option of not paying dividends may be more beneficial to investors from a tax perspective:
- Unqualified dividends are taxed for investors as ordinary income, which means that an investor’s tax rate on dividends is the same as their marginal tax rate.
- Marginal tax rates can reach 37% as of 2020.
- For qualified dividends, the tax rate is 0%, 15%, or 20%, depending on the marginal income tax bracket the investor is in.
- Capital gains on the sale of appreciated shares may have a lower long-term capital gains tax rate, usually up to 20% as of 2019, if the investor has held the shares for more than a year.
Companies often reinvest earnings instead of paying dividends, to avoid the potentially high costs associated with issuing new shares.
The following notable technology companies have historically declined to issue dividends:
The bottom line
When a company pays dividends, it returns part of its profits directly to shareholders, sending a signal to the market of stable and reliable operations. Newer companies, or those in the tech space, often choose to redirect profits back to the company for growth and expansion, so that they don’t pay dividends. Rather, this reinvestment of retained earnings is often reflected in an increase in share prices and capital gains for investors.