Why does a company ever pay a dividend instead of reinvesting in the business?

Well you actually learn about this if you take a financial accounting class. I forgot what the true answer is, but I think it’s something along the lines of sometimes primary shareholders just want to get paid, and the company can do that if they don’t have a better way to invest cash at that time. But there is a thought process involved on how much money.

Apple shareholders (which should be happy their shares are worth so much) are upset b/c Apple is sitting on a huge stockpile of cash (billions), and they think some of that should be payed out. But Apple instead chooses to use that money as part of a “strategy.”

Sorry I couldn’t be more specific. It’s been about 4 years since I’ve taken finance.

From my understanding, when a company has more retained profit/earnings than it has opportunities to reinvest, that’s when they pay out dividends.

(Sometimes companies do stupid things like borrowing money to pay dividends, and that’s a sign not that the company is saturated but that they’re up to something stupid. It pays to find out why they’re paying dividends if it seems unreasonable.)

When would a company actually not have a chance to reinvest? When they stop growing? That would mean paying a dividend would be a sign of struggling sort of. I’m guessing the board of directors, comprised of very large shareholders, must vote on it as a way of paying themselves instead of selling shares. Not sure. I’m thinking the logic may lie in how they are taxed, in that retained earnings don’t include dividend payments, so they can avoid paying taxes on some profits. Maybe there is a break even point.

I think investors need incentive to invest.

Both @mrrich724 and @laureth are right. I would add that there are companies (utilities in particular, but others also) which have been paying dividends for decades and whose stockholder base holds the stock purely for the dividends they receive. For them to cut a dividend or stop paying one, would severely affect their stock price. Still, if earnings dont justify it, it’s a bad sign.

So Coca-Cola’s been going downhill then? ;) And IBM? General Electric? More likely it’s a sign that they’ve reached a certain point of market saturation. At any given time, there are only so many opportunities for growth available, and the bigger a company is, the bigger the opportunity has to be to be worth the effort of investing in it.

@laureth Exactly! Great example of a company who can afford to pay dividends rather than reinvest the money!

Thanks.

Because companies are in business to make money for their shareholders. Return on investment (ROI) is the whole point.

@laureth I don’t know, that’s why I’m asking. Like a student in a class. That answer makes sense. The board will decide when it is wise to please stockholders vs reinvest in the company. So…how would they decide how large a dividend to pay? Obviously they have no problem leaving plenty of money in the coffers.

@plethora Stock price would decrease b/c investors would sell their shares out of displeasure?

I’m fairly uneducated in this field.

I bet that answer is different for each company.

They could sell their shares out of displeasure and buy another company that pays a higher dividend. More likely though, the demand for the stock would decrease, fewer people would want to buy it and then those that sell would have to sell at lower prices.

@Jeruba This is true. But some companies pay no dividend, but make a huge ROI for its investors in terms of appreciation in the price of the stock.

@plethora Is the dividend payout schedule and rate information available to the shareholder prior to purchasing the stock then?

@cockswain: You can read the prospectus for any company online.

Lots of good answers up there! The example of Apple is a good one, and you can look at Microsoft to see a similar example with a different ending. Generally speaking, companies that retain all their earnings and reinvest in the company are looking for growth, whether it’s investing in new products, or purchasing existing products or companies. Having a huge stockpile of cash helps that growth. Microsoft used to sit on hoards of cash, but finally under pressure from investors, started to pay out a very small dividend on a quarterly basis,. Many people who hold stocks really want the companies they own to share the wealth. Additionally, many people who are closer to retirement actually depend on their quarterly dividend checks from the various stocks they own as part of the income they live on.

Some people (like me) don’t really care about the dividend as long as the company has good growth potential. I’m a while from retirement, so the income aspect of investing in stock isn’t that important to me. Those stocks I have that DO pay dividends, I usually enroll in dividend reinvestment, which is a program that many companies offer whereby your quarterly dividend is used to buy more shares, rather than paid out in cash. This helps build your investment.

One more thing to note also about dividends (and it was the comment from @plethora above that made me think of this). The value of a dividend is not in how much a shareholder receives per share, but what the dividend is in relation to the stock’s price. For example, Company A and Company B both have a 50 cent dividend. Company A sells for $25 per share, and Company B sells for $50 per share. What this means is, Company A has an 8% dividend yield ($2 per year divided by the stock price), and Company B has a 4% dividend yield. That means if you’re looking for INCOME, then Company A may be a better investment. If you’re looking for growth, or don’t care whether your return comes from capital appreciation or dividends, then you need to look closely at both companies and determine for yourself which is the better investment.

Companies that pay dividends get brownie points on Wall Street. It helps with stock ratings, which encourages mutual fund participation as well as broker recommendations.

@nope
you are right

and tech companies are a great example. Tech continues to grow with seemingly limitless opportunities for new ideas, so the shareholder will not mind lack of dividends being paid, b/c a company like Apple will use that money to grow their product and the value of the share (hopefully) will increase anyway, so the shareholder will still benefit.

Whereas a company like Coca-Cola (used from previous example) doesn’t have as good a reason to hoard cash, b/c it’s not like “the next breakthrough advancement in soda” which requires heavy investment, is looming right around the corner.

@mrrich724 Well said. :)

I bought Apple at $40 and sold it at $20 (today it is trading at $219) ; I bought Microsoft at (well, I won’t mention that) and today it is $28.80. I call it the anti-Midas touch.