Why Companies Raise Their Dividend Payments

When shopping for a dividend stock to add to their portfolio, an investor may see that a company has recently increased their dividend payments. While this is generally a positive scenario, the investor should perform due diligence before purchasing the stock to ensure that they fully understand the reasoning behind the increase. A slight increase probably means the company is following their standard operating procedures, while a huge jump could be a red flag.

To Attract Investors

Most companies are interested in maintaining an upward trend in their stock prices to match or beat the inflation rate. When prices begin to stagnate or drop, many investors will sell their shares and force the price to go even lower. To battle this trend, a company may increase dividends to attract new investors. As shares are purchased, the stock prices stabilize or begin to increase again.

To Maintain Yield

Unless the dividend is increased, the yield will drop as the stock’s price rises. The relationship between stock prices and dividend payments is a delicate balance that is reported as the stock’s yield. Because many analysts judge the strength of a company’s stability based primarily on the dividend’s yield, a company will take measures to maintain a steady ratio. Yield is calculated by dividing the dividend payments by the stock price. To maintain the dividend yield, the dividend payment must be increased in proportion to any increase in stock price.

Intra-Industry Competition

In order to prevent the loss of potential shareholders to the competition, a company may increase their dividends to meet or exceed those paid by another company within their industry. In highly-competitive business areas, competition can be fierce with little to differentiate each brand other than stock prices and dividend yields. When everything else is even, the investor will typically choose a stock based on their potential return on investment (ROI) and purchase the stock with the highest dividend payment.

Display of Strength and Stability

In the stock market arena, steady dividend increases can be the ultimate show of strength and stability. The prestigious group of stocks commonly known as the Dividend Aristocrats has steadily increased their dividends every year for at least 20 years. Even if the increase is minimal, a company that is placed on this list will take steps to make sure they retain their position. A slow but steady dividend increase accompanied by a similar trend in the stock’s price will mark a stock as a dependable purchase.

Improved Earnings & Cash Flow

When earnings and cash flow have improved, a company will have a hard time explaining why they aren’t increasing their dividends. While some of a company’s profits can be expected to go towards reinvestment in the company’s future, each business also has a duty to the owners, their shareholders. If the investors review the company’s annual financial reports and notice a significant improvement that wasn’t shared with them, they may decide to sell their shares or vote in a new controlling board.

A Show of Confidence

While a current availability of cash is required to make a dividend payment, a dividend increase often indicates that a company is confident that their future cash influx will only increase. Before a company announces a dividend program or a dividend increase, most will have taken pains to forecast their future earnings to ensure the sustainability of the dividend payments. Canceling dividends once they have begun could cause many shareholders to sell. Of course, the whole picture must be taken into account before determining that this is the reason for the increase.

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