Dividends safe from stock market changes
Published 10:36 pm Thursday, September 10, 2015
By Arie Korving
Will a stock market drop affect my dividend payments?
We got this question from a client after the recent wild market ride. It is a great question.
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The quick and easy answer is “No, it shouldn’t.” And we could pretty much stop right there. But if you know us, you know we love to get into the explanation! So here goes….
Let’s go back to the very start, with “What is a dividend?” A dividend is a payment of a portion of a company’s earnings distributed to the company’s shareholders. Dividends typically are paid in cash, and the company’s board of directors decides the amount distributed.
Now the next question would be, “What causes a company to raise or lower their dividend?” The answer is cash flow. It all comes down to earnings and profitability and how much money the company has remaining after paying for all the things that keep it running, such as salaries, research and development, marketing and so on. After those expenses and the dividend payment, the remaining profits go back into the company.
When a company pays a dividend, its board is essentially saying that reinvesting all of the company’s profits to achieve further growth will not offer the shareholders as high a return as a dividend distribution.
That said, companies also offer a dividend as extra enticement for investors to buy their stock. Moreover, a steadily increasing dividend payout is an indication of a successful company.
Therefore, we can deduce that a company’s steady or increasing profitability will typically lead to steady or increasing dividend rates, and a decline in profitability will lead to that company reducing or eliminating its dividends. Most U.S. companies are loath to reduce their dividend rates, because it signals to investors that profits are lagging, which results in their stock prices getting pummeled. And that is not a good thing for a company’s board or management.
You will often see companies cut their dividends when there is a severe economic crash, but not in reaction to a market correction. Since dividends are not a function of stock price, market fluctuations and stock price fluctuations on their own do not affect a company’s dividend payments.
Here is an interesting tidbit: the term “dividend” comes from the Latin word dividendum, which means “thing to be divided.” With a dividend, companies are dividing their profits up among shareholders.
If you have a question, feel free to send it our way!
Arie Korving is a financial adviser and the founding principal of Korving & Co., Suffolk. Visit his website at www.korvingco.com.