Introduction
Before understanding why is declaring dividend good for a company, let us take a moment to set the context in appreciating the following:
- What is dividend.
- Why do companies declare dividend.
What is Dividend
Dividend can be defined as the portion of the profit made by the company, which are passed on to the investors / stakeholders as additional returns.
Management decides whether to distribute these profits as dividends to stakeholders or consider reinvesting them back into the company.
Why do Companies Declare Dividend
It is noteworthy to mention that, the company’s financial year profits cannot be directly withdrawn by promoters, investors, or stakeholders for their personal benefit.
There is a process wherein dividends are declared based on which the profits are proportionately shared between the various stakeholders.
For example, if Investor A holds 1000 shares of the company, Investor B hold 2500 shares of the company and the dividend declared is Rs. 25 per share. In this case, the Investor A will receive dividends of Rs. 25,000, while the Investor B will receive Rs. 50,000.
This way, the dividends are proportional shared between its stakeholders, depending on their degree of investment.
Also Read: 5 Reasons Why Companies Buy Back Their Own Shares.
Here are Reasons Why Is Declaring Dividend Good Thing for a Company
- Provide a reward to its stakeholders.
- Sends a positive message to its investors.
- Display financial stability in the markets.
- Attract more investors.
- Promotes investors to stay invested long term.
- Reduces the stock price volatility.
Provide a Reward to its Stakeholders
Giving out dividends is by far the best way to reward its investors for their continued support and trust in the company.
The portion of the profit is awarded and proportionately distributed between the investors and stakeholders.
This enables the investors to get a continued return on their investment, without them having the need to sell their shares to book gains.
Sends a Positive Message to its Investors
When a company declares dividends periodically, it sends a message that the company is financially strong and takes good care of its investors.
It is an indication that the company is performing financially well and the investors can continue to stay invested without any worry.
Declaring periodic dividends also creates confidence amongst investors, that the company’s future prospects are promising and stable.
Displays Financial Stability
It is needless to say that, when a company is declaring dividends to its investors, the company is making a statement that it is financially stable. The company has enough reserves and surplus cash to take care of the business in times of turmoil.
It shows that the company is generating enough cash flow and profits to return value to shareholders while still retaining enough capital to fund operations and growth.
Attracts more Investors
High dividend-paying stocks attract defensive investors who prefer stable companies and periodic dividend benefits.
Investors who are looking to invest in the equity markets, yet look for a periodic investment return, consider dividend payout stocks as the best option.
Promotes Investors to Stay Invested Long Term
The initial investors who had participated in the growth story of the company have multiplied their sock investment.
But there comes a time where the company now not focuses on growth but stability. Due to this, the stock’s price may not rise multiple times, presenting an opportunity for investors to exit and invest in another company.
In order to motivate the investor in staying invested, the companies are of the opinion to reward its investors with dividends.
Reduces the Stock Price Volatility
Investors often take advantage of companies that have reached stability and no room for growth, exiting the stock to book their profits. This can lead to a decline in the stock price over time.
Providing dividends motivates the investor to continue to stay invested. This reduces the volatility of the stock and stabilised the stock price.
Future Prospects
Generally large companies that are financially stable and not looking forward for any expansion ideally associate with declaring periodic dividends.
Companies with high dividend yields may experience exponential stock price escalation due to their stability and focus on growth. These are typically matured companies with a good amount of reserves and steady cashflow.
Conclusion
Whether declaring dividend or not is ultimately the management decision. In case of a growth company, it would make more sense to re-invest the profits for company’s future expansion.
Whereas, a stable, large cap company, may declare dividends to pass on the portion of their profits back to the investors.
You might also like: Why Are Growth Stocks Better Than Dividend Payout Stocks.
