When investing in stocks, investors can expect some of their assets to generate a dividend payment, a sum of money paid by a company to its shareholders out of its profits. Dividends are typically paid annually, but they can also be paid quarterly or monthly.
Dividends are paid from retained earnings, which are the profits that a company has kept after paying its expenses and taxes. When a company pays a dividend, it is sharing its profits with its shareholders.
Not all companies pay dividends. Some choose to reinvest their profits back into the business, such as by expanding operations or developing new products. Others may not be profitable enough to pay a dividend.
So does that mean stocks with low or even no dividend payments are bad choices? The simple answer is no. There are many reasons why investing in stocks with low or no dividends can benefit investors in the long run.
Investors want to see large numbers on their balance sheet, but when it comes to dividends, a lower payout may indicate that the company is reinvesting more of its earnings into growth, development or debt reduction, which can benefit shareholders in the longer term.
In some cases, companies may even choose to pay no dividends at all. For example, some of the world's biggest technology firms, such as Google parent company Alphabet, Facebook and Instagram owner Meta Platforms, Amazon, Biogen and Tesla, have historically declined to issue dividends.
This is because such companies have opted to reinvest their profits into innovation and expansion, experiencing major growth as a result.
Industries, circumstances differ
Different industries grow at different rates, with the factors that affect growth varying. Some industries, such as finance, tend to have more consistent growth trends, while others, such as the medical and tech industries, have seen more unpredictable growth post-pandemic.
The specific circumstances of each industry, such as the regulatory environment, technological advancements and consumer demand, all play a role in the rate of growth.
The management of a company in a rapidly growing industry may choose to reinvest most of their income back into the company to fuel further growth, or they may opt to distribute some of the profits to shareholders in the form of dividends.
The decision will depend on a number of factors, such as the company's financial goals and the outlook for the industry.
The unpredictable growth some industries experience can be a double-edged sword. On the one hand, it can provide companies with a unique opportunity to capitalise on the sudden growth rate and expand operations.
On the other, it can also lead to temporary declines in revenue, which can force companies to reserve capital to weather the storm.
A good example would be oil and gas company Shell. On April 30, 2020, Shell cut its dividend by 66 per cent to 16 US cents a share, the first reduction since 1945, to preserve cash and reinforce the resilience of its business amid Covid-19 and the collapse in oil prices.
This allowed the company to navigate the effects of the pandemic, which hit the oil and gas industry hard.
Stock price preservation
As dividends represent a cash outflow from the company to shareholders, they affect the stock price.
When a company pays a dividend, its stock price usually drops by the amount of the dividend to reflect the fact that new shareholders who bought shares after the ex-dividend date are not entitled to that payment.
A lower dividend may reduce the drop in the stock price and preserve the market value of the company.
For example, Advance Auto Parts reduced its dividend from $1.50 to $0.25 per share in 2023, but its stock price increased by 6.5 per cent on the day of the announcement as investors reacted positively to the company’s earnings report and revised guidance.
This can result in a great opportunity for investors to sell their shares for a higher return margin.
Company development stage
Dividends are also influenced by a company’s maturity, industry and business cycle.
With a new or growth-oriented company needing to reinvest earnings to expand and innovate, it may pay dividends at a lower rate, or none at all.
A more mature or stable company may pay higher or more consistent dividends as it has less need for reinvestment and greater cash flow.
A lower dividend may reflect the company’s stage of development or its response to changing market conditions.
For example, Macy’s, the US department store chain founded in 1858, lowered its dividend from $0.1654 to $0.1650 per share in 2023, a negligible decrease that signalled the company’s confidence in its recovery from the pandemic-induced economic slump.
The company also reported better than expected earnings and raised its outlook for the year.
Income investors and growth investors have different investment goals, and this is reflected in the payout ratios they prefer.
Income investors seek to generate a steady stream of income from their investments, so they look for stocks with high dividend payout ratios.
Higher dividend payout ratios push up dividend yields, which is the amount of income received from a stock as a percentage of its price, which means income investors can achieve their cash flow goals with less capital invested.
Growth investors, on the other hand, are more interested in capital appreciation.
They believe that by reinvesting earnings back into the business, the company can grow its profits and share price over time.
Growth investors prefer stocks with lower dividend payout ratios.
Ultimately, the best payout ratio for an investor will depend on their individual goals and risk tolerance.
Income investors should look for stocks with high dividend payout ratios, while growth investors should look for stocks with lower dividend payout ratios.
So with such a range of factors to take into account, investors should consider carefully when choosing stocks based on dividends.
Prepared by: Cambodia Securities Exchange (CSX), Market Operations Department.
Email: [email protected].
Tel: 023 95 88 88 / 023 95 88 85.