“Will a stock market drop affect my dividend payments?”
We got this question from a client of ours last month after the wild market ride. It is a great question.
The quick and easy answer is “No, it shouldn’t.” And we could pretty much stop right there. But if you know us, you know we love to get into the explanation. So here goes…
Let’s go back to the very start, with “What is a dividend?” A dividend is a payment of a portion of a company’s earnings distributed to the company’s shareholders. Dividends typically are paid in cash, and the company’s board of directors decides the amount distributed.
Now the next question would be, “What causes a company to raise or lower their dividend?”
The answer is cash flow. It all comes down to earnings and profitability and how much money the company has remaining after paying for all the things that keep it running, such as salaries, research and development, marketing, etc. After those expenses and the dividend payment, the remaining profits go back into the company.
When a company pays a dividend, its board is essentially saying that reinvesting all of the company’s profits to achieve further growth will not offer the shareholders as high a return as a dividend distribution. That said, companies offer a dividend as extra enticement for investors to buy their stock. Moreover, a steadily increasing dividend payout is an indication of a successful company.
Therefore, we can deduce that a company’s steady or increasing profitability will typically lead to steady or increasing dividend rates, and a decline in profitability will lead to that company reducing or eliminating its dividends. Most U.S. companies are loathe to reduce their dividend rates because it signals to investors that their profits are lagging, which results in their stock price getting pummeled. And that is not a good thing for their company’s board or management.
The final long-winded answer: You will often see companies cut their dividends when there is a severe economic crash, but not in reaction to a market correction. Since dividends are not a function of stock price, market fluctuations and stock price fluctuations on their own do not affect a company’s dividend payments.
Arie Korving is a longtime financial adviser and the founding principal of Korving & Co. in Suffolk. For more information, visit www.korvingco.com or call 638-5494.
Given the intricacies of dividend payments and their relationship to market fluctuations, let's break down the concepts used in the article you provided:
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Dividends: These are payments made by a company to its shareholders out of its profits. Dividends are typically distributed in cash and are decided by the company's board of directors.
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Factors Influencing Dividend Changes: The primary factor affecting whether a company raises or lowers its dividend is its cash flow. The company's profitability and earnings determine how much money remains after covering operational expenses like salaries, R&D, marketing, etc. Whatever remains after these expenses and dividend payments is reinvested back into the company.
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Purpose of Dividends: Dividends are essentially a way for a company to distribute its profits to shareholders. Companies pay dividends when they believe reinvesting all profits won't offer shareholders as high a return as a dividend distribution. Additionally, steadily increasing dividends indicate a successful company and can be an enticing factor for investors.
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Impact of Profitability on Dividends: A company's steady or increasing profitability usually leads to steady or increasing dividend rates. Conversely, a decline in profitability can result in a company reducing or eliminating its dividends. Companies are usually reluctant to decrease dividend rates as it signals a decline in profits, which can negatively affect their stock price.
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Dividends and Market Conditions: Companies might cut dividends during severe economic crashes but typically don’t do so in reaction to market corrections. Dividend payments are not directly tied to stock prices or market fluctuations, so changes in stock prices alone do not affect a company's dividend payments.
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Expert Insight: The article is penned by Arie Korving, a seasoned financial adviser with extensive experience in the field. His understanding of dividends, their relationship with a company's profitability, and their connection (or lack thereof) to market fluctuations lends credibility to the information provided.
Understanding these concepts helps clarify that stock market drops might not directly impact dividend payments. Instead, a company's financial health and profitability primarily influence whether dividends are raised, lowered, or maintained.
