A company might increase its dividend for a number of different reasons. Since a dividend represents a portion of company profits that is being paid to shareholders, news of a dividend increase is typically viewed as a positive development because it suggests that the company is confident in its future.
However, a dividend increase can also be a sign that the company is running out of growth opportunities and is decided to, rather than invest, distribute some of its excess cash flow to shareholders.
Key Takeaways
- Dividends represent company profits that are paid to shareholders.
- When a dividend increase is the result of improved cash flows, it is often a positive indicator of company performance.
- Another reason for a dividend hike is a shift in company strategy away from investing in growth and expansion.
- A company might also raise its dividend to attract additional equity investments by offering more attractive dividend returns to investors.
- A stable dividend payout ratio is typically viewed as a positive sign.
Dividend Increases
There are two primary reasons for increases in a company’s dividend per share payout.
- The first is simply an increase in the company's net profits out of which dividends are paid. If the company is performing well and cash flows are improving, there is more room to pay shareholders higher dividends. In this context, a dividend hike is a positive indicator of company performance.
- The second reason a company might hike its dividend is because of a shift in the company’s growth strategy, which leads the company to expend less of its cash flow and earnings on growth and expansion, thus leaving a larger share of profits available to be returned to equity investors in the form of dividends.
There are a number of reasons why a company might decide to reinvest a smaller portion of its profits into growth and expansion projects. Depending on the size of the company, production capabilities, and similar factors, the extent to which a company can grow may be at least temporarily limited. The company might be concerned about its ability to increase production sufficiently to meet increasing demand if it pushes too far, too quickly in expanding its market.
Unfavorable financing rates may also lead the company to postpone major capital expenditures. A rapidly growing company may wish to consolidate its gains and reassess its market position before committing further funds to expansion. There is also the possibility a company may decide to increase its dividend payout to attract further equity investment by offering more attractive dividend returns to investors.
Dividend Yield vs. Dividend Payout
The two main dividend-related equity valuation metrics used to evaluate a company's overall investment potential and specific income investing potential are dividend yield and the dividend payout ratio.
While dividend yield is perhaps a more commonly viewed figure by retail investors, the dividend payout ratio is a metric that is favored by some savvy investors. The dividend payout ratio shows the percentage of a company’s earnings being paid to shareholders in the form of dividends. On the other hand, dividend yield is computed by dividing the annual dividend per share by the current share price.
A stable dividend payout ratio over time is considered a favorable sign for investors, as it indicates a financially sound company with earnings adequate to support continued positive dividend yields for investors. Analysts prefer the payout ratio to dividend yield, as a company's current yield is subject to the whims of the market and may be an unsustainable figure over the long term.
The Bottom Line
Companies that increase their dividends send a positive signal to investors and analysts that the company can maintain growth and profitability into the future. As a way to distribute profits to shareholders, dividend increases can attract new investors who seek income in addition to capital gains in their portfolio. Investors should pay attention to the dividend yield, which is dependent on the stock's price versus the payout ratio, which has to do with earnings instead, when making decisions to invest in a dividend stock.
FAQs
Dividends represent company profits that are paid to shareholders. When a dividend increase is the result of improved cash flows, it is often a positive indicator of company performance. Another reason for a dividend hike is a shift in company strategy away from investing in growth and expansion.
What causes dividends to increase? ›
A higher yield can occur when the stock price falls due to a decrease in the company's earnings or because of declining investor sentiment. In some cases, struggling companies may increase dividends to boost yields and attract new investors.
What determines dividend per share? ›
Dividend per share (DPS) is the sum of declared dividends issued by a company for every ordinary share outstanding. DPS is calculated by dividing the total dividends paid out by a business, including interim dividends, over a period of time, usually a year, by the number of outstanding ordinary shares issued.
Why do dividend amounts change? ›
The reason for the adjustment is that the amount paid out in dividends no longer belongs to the company, and this is reflected by a reduction in the company's market cap. Instead, it belongs to the individual shareholders.
Do stock dividends increase? ›
It's also important to understand that a stock's price and its dividend yield move in opposite directions as long as the dollar amount of the dividend doesn't change. For example, if the stock price in our example dropped from $147 per share to $100, its dividend yield would rise from 2.37% to 3.48%.
Do dividends increase with share prices? ›
After the declaration of a stock dividend, the stock's price often increases; however, because a stock dividend increases the number of shares outstanding while the value of the company remains stable, it dilutes the book value per common share, and the stock price is reduced accordingly.
What is a good dividend per share ratio? ›
Generally speaking, a dividend payout ratio of 30-50% is considered healthy, while anything over 50% could be unsustainable.
Is it better to have higher or lower dividends per share? ›
Dividend Per Share Analysis
The DPS calculation is an accurate way to tell how much the shareholders will get paid. However, looking at the trend of dividend payments can tell us a lot about that specific company and its growth. The higher the dividends from the company, the better they are projected to do.
What does a higher dividend per share mean? ›
This signals the company is financially stable and performing well in its current market condition. An increase in DPS also signals the management team is confident in the company's future profits.
What affects dividend payout? ›
Dividend payouts depend on many factors such as a company's debt load; its cash flow; its earnings; its strategic plans and the capital needed for them; its dividend payout history; and its dividend policy.
These companies want to keep the majority of earnings within the company to help it grow and to provide room for growth. Low dividend payouts give the company room to grow, which, in turn, can lead to more profits for the company, which, in turn, can lead to higher dividend checks for investors.
Are increased dividends good? ›
“Companies that have consistently increased their dividends tend to be more stable, higher quality businesses, which historically have weathered downturns and are more likely to have the ability to pay dividends consistently.”
What is the difference between dividend per share and dividend yield? ›
While dividend yield refers to the percentage of the current stock price of a company paid out as dividend over a year, dividend rate is the amount of money that company pays to its shareholders as dividends on per-share basis.
How often do dividends change? ›
While a stock's dividend may hold steady quarter-after-quarter, its dividend yield can change daily, because it is linked to the stock's price. As the stock rises, the yield drops, and vice versa.
Do dividends increase with inflation? ›
Many Dow Jones industrials have dividend yields much higher than the current rate of inflation. A look back at history shows that dividends have performed well during periods of inflation and even stagflation, which refers to persistent high inflation combined with high unemployment and stagnant demand.
How much do dividends increase over time? ›
An average dividend growth rate is 8% to 10%. However, this can vary greatly among different stocks and industries.
What do cash dividends increase? ›
Examples of How Cash Dividends Affect the Financial Statements. When a corporation's board of directors declares a cash dividend on its stock, the following will occur: Retained earnings (a part of stockholders' equity) will decrease. Current liabilities (such as Dividends Payable) will increase.
