Does Paying Dividends Increase the Stockholder's Equity?

by Nola Moore, studioD

Even if you're new to investment analysis, you probably know that dividends are viewed positive and that a high ratio of stockholders' equity (SE) per share also is positive. While a healthy company theoretically has both these things, you may find that companies that pay dividends don't have as high an SE as you expected and vice versa. The truth is that dividends don't increase SE. In fact, they decrease it.

Making a Profit

All companies are in business to make money. The money they bring in is known as revenue. Revenue doesn't equal profit, however. Profit is what you have left over after you subtract all your expenses from your revenue. As a publicly traded corporation, you can pay that profit out to stockholders as a dividend or you can keep it, in which case it is called retained earnings. Most companies keep at least some of their profits to invest in future business plans, but they pay out what they don't need. If the company is growing quickly or times are tough, they may not pay out anything at all.

Retained Earnings and Stockholders' Equity

Stockholders' equity takes the profit equation one step further. SE adds everything the company owns that has value -- its assets -- to the retained earnings and subtracts all the money the company owes but hasn't paid yet -- its liabilities. This means that dividends, which are paid out of the retained-earnings account, remove value from the assets and reduce SE overall.

Dividends Aren't Bad

Even though they reduce SE, most investors see dividends as a good thing. At the simplest level, this is because dividends are cash in stockholders' pockets. After all, owning stock entitles you to a portion of company profits, and that's exactly what a dividend is. When you get a dividend, you also get the opportunity to choose how it's spent. You can buy more stock and reinvest in that company, you can buy another company's stock, or use it for something else entirely, like going out for ice cream.

Retained Earnings Aren't Bad, Either

The only time a dividend is bad is when that money should be spent on the issuing company's business. Retained earnings are cash in the company pockets and don't come with interest payments like a loan or bond do. Earnings are a relatively painless way to shore up and expand the business. With proper management, this reinvestment will result in higher profits and more money for investors down the line, either through higher stock prices or increased dividends, or both.

About the Author

Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.