Stock dividends have great importance to both the companies that issue them and the shareholders who receive them. Some of this importance is based on tangible results from the distribution of money. But the symbolic meaning behind dividend payments is also significant.
A stock dividend is a distribution of company earnings to shareholders. This is an alternative to retaining earnings to cover future expenses and to reinvest in company growth. Companies that issue dividends on an ongoing basis usually do so monthly, quarterly or annually. Dividends are paid based on a certain rate per share of ownership. For instance, a 10-cent dividend on 1,000 shares equals $10.
Dividends are not just a way for a company to distribute income. They are also used to attract income-driven investors. When a company issues dividends, this is typically a sign that the company is comfortable in its cash position. Long-term investors often prefer dividend paying stocks because dividends offer an opportunity for ongoing return on investment. This adds value to the potential of making money when the stock price appreciates. Regular dividends also help retain investors who might otherwise sell, which keeps share prices stable.
Paying dividends with excess cash also has some ethical importance. The earnings of a corporation are technically owed to its owners. However, a company's board of directors can choose to reinvest earnings in the business as long as they can justify that doing so is in the best interest of the company and its owners. Companies that sit on large stockpiles of cash with little effort to grow or expand sometimes draw the ire of stockholders and the Securities and Exchange Commission.
When a company chooses not to pay a dividend, this also sends important signals to the market. In general, a company would not pay a dividend because it either has no money to do so, or prefers to reinvest in growth. By looking over a company's financial statement, you can typically discern which is the case. If its balance sheet is low on cash, it probably doesn't have the money to pay dividends. Investors looking for aggressive growth opportunities often prefer that a company reinvest earnings to help increase profitability and grow the share price. These types of investors might have concerns that dividend-paying companies see limited growth potential.
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