What Are 4 Reasons a Company Might Suspend Its Dividend?
Dividend-bearing stocks are popular among a wide variety of investors, so when a company decides to suspend its dividend payments, it can be a signal to sell for many shareholders.
Of course, those who own a stock primarily for the benefit of annual dividend payments are most likely to abandon ship. However, even investors who employ a buy-and-hold strategy may turn tail and run if a company that traditionally pays consistent dividends unexpectedly declares a suspension.
While a company suspending its dividends can be a sign of a struggling enterprise, not all dividend suspensions foreshadow corporate failure.
Key Takeaways
- Many companies pay dividends as a way to return profits to investors.
- Some companies, however, choose to retain earnings in order to fund new growth opportunities.
- Companies may also suspend regular dividends in response to financial troubles or unforeseen large expenses.
Understanding 4 Reasons a Company Might Suspend Its Dividend
Reason 1: Financial Trouble
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.
If revenue is down or costs are up, the amount of money left over for dividends at the end of the year may be minimal or nonexistent. Sometimes, dividend suspensions may be announced out of necessity, meaning there is no profit to distribute, or out of proactive financial planning, meaning profit margins are not large enough to warrant any nonessential spending.
Reason 2: Unexpected Expenses
Another reason a company may suspend its dividends is due to unexpected one-time expenses that temporarily reduce profits. Even if revenues remain constant year to year, a lawsuit judgment against the company or the need to replace or update costly equipment may require the company to use its earnings for other purposes.
In these scenarios, dividends are generally reinstated as soon as the unexpected expense is satisfied. Shareholders that jump ship at the first sign of trouble may be sacrificing future dividends and capital gains because they failed to research the cause behind the suspension. Not all dividend suspensions are cause for shareholder panic.
Reason 3: Funding Growth
Dividends are issued out of a company's retained earnings, which represents the total amount of profit accumulated over time that has not been previously distributed as dividends in prior years or otherwise used up.
Outside of dividend payments, one of the primary uses for retained earnings is to fund growth projects that, while temporarily costly, promise to provide increased income in the future. If a company decides the time is right to open a new location, expand its product line, or reach out to a new market segment, it may dip into its retained earnings to fund the growth. In this case, dividends may be suspended temporarily to facilitate increased earnings.
Again, shareholders who dump a stock that suspends dividends to fund growth may be missing out on accelerated capital gains and increased dividends in future years.
Reason 4: To Defer Preferred Dividends
Dividend distributions can be a little complicated because there are two types of stock that a company can issue. Most stock is considered common stock, and dividends are issued at the discretion of the issuing entity.
However, many companies also issue preferred shares that do not carry the same ownership rights as common stock but do provide a guaranteed dividend amount each year, which is typically higher than the dividend received by common shareholders.
To issue dividends to common shareholders, the company must first pay back any dividends due to preferred shareholders. In some cases, a company may have the funds necessary to pay a common dividend but not to pay both preferred and common dividends. In this case, a company may choose to pay preferred dividends but suspend common dividends or decide to suspend all dividends entirely.
However, any preferred dividends that are deferred must be paid before any common dividends can be distributed. In this case, common dividends may be suspended indefinitely so the company can afford to pay preferred shareholders. Companies that have to suspend preferred dividends fight an uphill battle against ever-increasing overdue payments in subsequent years, so this is not a popular choice unless the company is in serious trouble.
FAQs
Many companies pay dividends as a way to return profits to investors. Some companies, however, choose to retain earnings in order to fund new growth opportunities. Companies may also suspend regular dividends in response to financial troubles or unforeseen large expenses.
Why would a company suspend dividends? ›
Many companies pay dividends as a way to return profits to investors. Some companies, however, choose to retain earnings in order to fund new growth opportunities. Companies may also suspend regular dividends in response to financial troubles or unforeseen large expenses.
Why does a company stop paying dividends? ›
Companies in the growth stage rarely pay dividends. In fact, many of these companies are not even profitable yet. They are focused on acquisitions, expansion, product development and all of these other things that cost a lot of money. As a result, they simply cannot afford to pay a dividend.
What are the 4 dividend policies? ›
There are four major types of dividend policies: regular dividend, irregular dividend, stable dividend, and no dividend. Dividend policies dictate how a company decides to distribute its earnings to its shareholders.
What are some reasons that a corporation might not pay dividends? ›
Companies that expand quickly typically won't make dividend payments. That's because it's fiscally shrewder to re-invest the cashback into operations during pivotal growth stages. But even well-established companies often reinvest their earnings to fund new initiatives, acquire other companies, or pay down debt.
Why do companies suspend shares? ›
Suspended trading occurs for many different reasons, including: A lack of current, accurate, or adequate information about a company, such as when it's not current in its filing of periodic reports. Questions about the accuracy of publicly available information, including the contents of recent press releases.
Why would a company cut their 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.
What are the reasons for not paying dividends? ›
Highlights. Firms pay no dividends due to cash constraints and investment opportunities. Firms do not pay dividends because of poor profitability and earnings. Firms avoid paying dividends due to the cost of raising external funds.
Why a company can justify not paying dividends? ›
A company can justify not paying dividends because it allows the company to maintain a warchest of cash that can be used for various strategic purposes. One reason for this approach is because personal taxes on dividends are often higher than taxes on capital gains.
Did he suspend its dividend? ›
What are the Company's plans for the dividend? The HEI Board determined that suspending the quarterly cash dividend would allow us to continue to allocate cash to rebuilding and restoring efforts and best position us to serve our customers and communities.
There are several factors which affect dividend policy, the most important of which are the following: (a) legal rules, (b) liquidity position, (c) the need to pay off debt, (d) restrictions in debt contract, (e) rate of expansion of assets, (f) profit rate, (g) stability of earnings, (h) access to capital markets, (i) ...
What is the rule 3 of dividend rules? ›
Rule 3 of Dividend Rules prescribes the conditions to be complied with for declaring dividend out of reserves. A pertinent question here is – whether a company can declare dividend out of 100% of the amount that has been transferred to General Reserve.
What does it mean to suspend a dividend? ›
The Bottom Line. 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.
What is one reason a corporation might not pay a dividend to shareholders? ›
A company with a focus on reinvesting all of its earnings will naturally skip the dividend-payment process. These are the companies that choose to retain earnings in order to be able to finance new growth opportunities and expand its operations.
Can a corporation withhold dividends? ›
Key Takeaways. U.S. corporations are allowed to exclude a portion of the dividends they receive from other corporations in order to avoid double taxation. The federal dividends-received deduction applies only to corporations and not to individuals who receive dividend income.
When can dividend be revoked? ›
Revocation of dividend
Once declared, a dividend, including an interim dividend, becomes a debt and cannot be revoked without shareholder approval. A dividend that is declared and distributed to shareholders cannot be altered by a subsequent resolution.
What circ*mstances might cause directors to cancel a dividend that has been declared? ›
When there are unexpected expenses, organization funding growth, dividends declared can be revoked. Yes, there is a time limitation to revoke dividends once declared. The time when the board of directors should cancel the dividends is before the payment time is fixed. Once the time is fixed, they cannot be revoked.
What are dividend traps? ›
A dividend trap is where the stock's dividend and price decrease over time due to high payout ratios, high levels of debt, or the difference between profits and cash. These situations commonly produce an unsupported but attractive yield.
