Effects of Dividends on Penny Stocks

by Dennis Hartman

Investing in the stock market can take many forms, covering stock in a wide range of businesses and all levels of investor risk. Penny stocks, which are stocks with a value of less than $5 per share, are one option on the fringes of the stock market. Penny stocks may include dividends, but they carry risks that require investors to exercise special care.

Cash Dividends

Some penny stocks issue cash dividends, which are regular cash payments for each share a stockholder owns. Cash dividends have the initial effect of attracting investors to a given stock, since they can earn income without selling their shares, as the stock pays its dividends each quarter or each year. However, cash dividends also create special risk in penny stocks. Since penny stocks represent ownership in small and struggling businesses, the dividends they offer may disappear at any time and without warning. This means that investors can't count on dividend payments from penny stocks as they plan their financial futures.

Stock Dividends

Another type of dividend that a penny stock may issue is a stock dividend. This represents additional stock in the same company, which the company issues in fractions of shares based on how much stock current shareholders own. Stock dividends dilute penny stocks, since they increase the number of outstanding shares. However, they also give investors new opportunities to profit and may attract new buyers. In addition, stock dividends don't require the company to spend a large sum of cash all at once, though cash dividends do.

Penny Stock Status

If a penny stock begins to offer dividends while its value is still relatively low, the dividend may affect its status as a penny stock. This can occur if renewed interest from investors due to the promise of dividend payments, at least in the short term, drives the share price up above the traditional $5 threshold. While this is good for the value of the businesses that issue penny stocks, it may give them reason to restructure themselves and list their stock on more well known exchanges.

Reducing or Eliminating Dividends

Just as adding or maintaining a dividend can draw investors to a penny stock, eliminating or reducing that dividend can have the opposite effect. For example, if a business has a stock price of $10 per share at its peak and sees its share price fall to $5 during a period of economic decline, its board of directors may vote to eliminate a dividend that it authorized when the stock value, and cash reserves, were high. This action is likely to depress the stock price even further as investors sell off their shares and seek investments that do pay dividends. The business's growth potential, leadership and ability to rebound from decline will also impact investors' decisions.

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