When a person invests in a stock, stock dividends are one possible benefit of that investment. These dividends represent money earned on the stock, which is generally paid out on a quarterly basis. Stock dividends can provide a steady source of income as long as the stock gains in value, but they also change the stockholders' equity in the company.
What is Stockholders' Equity?
The stockholders' equity, also referred to as owners' equity, refers to the amount that a corporation is worth to stockholders once all of the expenses and losses have been deducted. This same number, representing the company's profits minus expenses, can also be considered the company's net worth or the monetary value of the company. The amount of stockholders' equity also equals the funds that the company has to operate without borrowing or earning additional money.
What Causes Equity to Increase?
Stockholders' equity in a company increases in two different ways. The first way is through the sale of additional stocks in the company, which raises the company's working capital and net worth. The second way is through direct business profits, which also raise the company's net worth. If a company earns $10,000 through the purchase of stock, creates a $10,000 product and sells it for $40,000, the $30,000 becomes part of the stockholders' equity, despite the fact that it wasn't originally earned through stock purchases.
Do Dividends Raise Equity?
When a company owes or spends money, that money becomes a loss or expense for the company, which lowers the company's net worth and stockholders' equity. Since stock dividends pay out from the company to individual stockholders, dividends are just one form of company expense. So, instead of raising stockholders' equity in a company, dividends paid out to stockholders decrease the stockholders' equity in a company.
Why Give Dividends?
Since paying out dividends to stockholders actually decreases the stockholders' equity, some companies choose not to pay out dividends. Instead of paying dividends, those companies reinvest the profits earned each quarter back into the company to increase the net worth of the company and, therefore, the stockholders' equity. Other companies pay out dividends to show that the company is thriving financially, which helps retain those individuals who have invested in the company stock.