What Changes in Dividends Affect Stock Price?

by Dennis Hartman

There are several ways to make money by investing in stock. One option for investors is to hold shares and earn money from dividends, which are cash payments that companies offer to their shareholders as investment incentives. But dividends are voluntary, and when a business changes its dividend offering by any amount it can affect the stock's price.

What Dividends Indicate

Businesses are free to change the level of stock dividends at any time. Most business pay dividends quarterly, with each stockholder receiving the flat dividend rate for each share he owns. Businesses fund dividend payments out of their retained earnings or earnings from investments. This means that when a business increases its dividend, it serves as an indication that the company has strong earnings and the ability to spend more on dividends. Likewise, when a business reduces its dividend, it may indicate an inability to pay or uncertainty about having the money to pay dividends in the future.

Dividend Increases

A stock's price is likely to increase if the company announces a significant and unexpected boost to its dividend rate. This occurs for a number of reasons. By increasing the dividend, the business signals that it has the money to do so. It also ensures that its investors will receive even more cash in the form of dividends, even if the share price falls in the future. This offsets some of the risk of investing and increases demand, which in turn drives up share prices.

Dividend Cuts

Dividend cuts of any size can cause a stock's value to fall, sometimes sharply. This occurs when investors, who have been receiving dividend payments in a certain amount for as long as they've held a particular stock, are faced with the prospect of decreased investment income. Selling shares allows an investor to get cash to invest in a business with a higher dividend, but it also drives down the price of the shares of the business that announced a dividend cut. Dividend cuts also bode poorly for future investing, since a business with a low dividend will need to work harder to attract investors who have better options elsewhere in the market.

Effects of Dividend Payment

When a company actually pays out a dividend that is identical, or similar, to its recent dividend offerings, the payment is unlikely to affect stock prices in any meaningful way. This is because all stock investing involves predicting the future value of a business and its shares. When buyers and sellers come together on a share price, this price reflects not only the current dividend that the stock includes but also expected changes in the near future. In other words, the stock market factors dividend amounts and likely changes into share prices as soon as investors become aware of them. Unexpected dividend changes, regardless of amount, are the most likely to change stock prices.

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