Posted on | March 11, 2013 | Comments Off
Dividends are an important part of the equation when you want to assess a company as an investment. Dividends that are paid out at regular intervals are a sure sign of the good health of a company. Therefore, companies pay out dividend not just to share their profits with their shareholders, but also to signal that their finances are in good health. However, not all companies pay dividends; in the following sections we seek to understand some of the major reasons why would a company not pay stock dividends.
1. No Profits or Earnings
This is perhaps the most common reason why a company may not pay out any stock dividends: a company just may not have any money to pay dividend with. One can find out more about a company’s finances by going over its quarterly or annual balance sheet. Such a balance sheet should tell you how much debt, credit and profits the company had for the period in question. If a company does not have any operating profit, or is in the red, then it should not be a surprise that it won’t pay any dividend. If a company cannot maintain a profit for many quarters, then it is certainly plausible that it will soon declare bankruptcy or otherwise cease operations. However, this is the worst case scenario. There are scenarios where profitable companies many not pay out any dividends, as we seen in the next sections.
2. Contractual Obligations
In many types of contracts, including contracts undertaken as a borrower, a company may be obligated to not pay out any dividend. Such a condition may be put by lenders who want the company to service their debt first before it pays out any dividend to its shareholders. They want the company to give more importance to their debt so that they can get back their money in due time. It should be noted that when a company is contractually obligated to not pay out any dividend, it will most likely announce it publically.
3. Tax Reasons
In many instances, a company may find that spending money on a particular expense of project is more profitable because it brings tax benefits for the company. In such a scenario it may eschew paying out dividend and rather spend the money for such an expense.
4. Reinvesting Profits Back in Company
A company needs capital to grow, and most companies require debt of one form or another. In a situation when a company is under debt, and requires capital to grow, the company board may rightly come to the conclusion that it is in the long term interests of the company to reinvest its profits back in the company rather than pay out a dividend. By reinvesting in the company, the company grows faster. This was the case with Berkshire Hathaway, the holding company controlled and run by Warren Buffet. Berkshire Hathaway is notorious for never having declared a dividend, which explains its high growth rate. It is normally observed that fast growing companies do not pay out any dividend because they need all the money they can get to reinvest in their operations. Once a company is established in its domain, it can then share its profits with its shareholders.
These are the main reasons why not all companies would pay dividends. There could be some other issues at hand as well. I understand however when someone would wonder why not every company would since many people seek out dividends and this is a strong factor in them considering purchasing a stock in order to receive some passive income while hoping for the stock itself to increase in price. It is true that dividends can be a strong lure to get people to purchase stock in a company but it is not this alone that people should look for. Issues to do with a companies worth and other numbers should also be considered in the overall picture. Many people however that have dividends coming in regularly appreciate their passive income and may help them from having to get an online loan or other means to obtaining money. I personally have my dividends automatically coming out of my account each year into a spending account to enjoy the fruits of my labor, or lack there of. Or it may be used to pay a few bills I have etc. If you can afford it, re-investing these dividends can really help your portfolio to grow as the dividends can compound and be used to buy more shares. Its really up to you.