Dividend Cuts
A portion of a company's net profits can be allocated toshareholders asa dividend, or kept within the company asretained earnings.Dividend payments are decided by the board of directorsand must be approved byshareholders.These payments can be issued as cashor as shares of stock.
A dividend cut occurs when a dividend-paying company either completely stops paying out dividends (usually a worst-case scenario) or reduces the amount it pays out. This most often leads to a sharp decline in the company's stock price, because this action is usually a sign of a company's weakening financial position, which makes the company less attractive to investors.
Key Takeaways
- Dividend cuts are most often a negative sign for a company's financial health.
- Companies usually make drastic dividend cuts because of financial challenges like declining earnings or mounting debts.
- Sometimes companies may cut dividend payments for more positive reasons, like preparing for a major acquisition or a stock buyback.
Understanding Why Dividends May Be Drastically Cut
Most Often Bad News
Dividends are usually cut due to factors such as weakening earnings or limited funds available to meet the dividend payment. Typically, dividends are paid out from the company's earnings, andif earnings decline over time, the company either needs to increase its payout rate or access capital from other places, such as its short-term investments or debt, to meet the past dividend levels.
If the company uses money from non-earnings sources or takes up too much of the earnings, it may be putting itself into a compromising financial position. For example, if it has no money to pay off its debts because it is paying out too much in dividends, the company could default on its debts. But usually, it won't come to this, as dividends are usually near the top of the list of things cut when the company is faced with financial challenges.
This is exactly why dividend cuts are seen as a negative. A cut is a sign that the company is no longer able to pay out the same amount of dividends as it did before without creating further financial difficulties.
Not Always Bad News
While most investors rightly consider a drastic dividend cut a negative sign for a company's health, on some occasions, it is not such a harbinger of doom for a company.
Under certain conditions—for example, when the pricing and conditions are just right for a stock buyback; weathering a major recession becomes the priority; or a company needs to accumulate cash on hand for a big merger or acquisition.
In these cases, a dividend cut—even a rather drastic one—may not necessarily be a sign of trouble, or even a sign that selling the stock is your best course of action. Like with any and all financial decisions, doing due diligence and careful research is key to successful investing.
The Bottom Line
Companies that can grow their dividends are seen as stable and attract investors looking for income as well as capital gains. Sometimes, however, it can hurt a company's bottom line to distribute profits as dividends rather than retain earnings to solidify the company's financials. Companies may cut dividends in response to an economic downturn, a spate of negative earnings, or more serious threats to the company's health. Other times, the cut may be more strategic and orient towards future growth or allow for buybacks.
FAQs
Companies usually make drastic dividend cuts because of financial challenges like declining earnings or mounting debts. Sometimes companies may cut dividend payments for more positive reasons, like preparing for a major acquisition or a stock buyback.
Why do companies cut their dividends? ›
Large, stable corporations almost never cut dividends as a strategic choice. Instead, they reduce dividends only when they have low earnings or when challenging economic conditions force their hand. CFOs frequently ask whether they should cut dividends to invest in growth.
What causes dividends to decrease? ›
"More seriously, companies that cut their dividends could be signaling trouble." They might be anticipating weak sales, or less profit due to higher operating costs, or management turnover -- any of which could cause a significant stock drop.
Why would a company stop paying dividends? ›
The chief cause of a dividend suspension is the issuing company is under financial strain. Because dividends are issued to shareholders out of a company's retained earnings, a struggling company may choose to suspend dividend payments to safeguard its financial reserves for future expenses.
What does it signal to investors when a firm cuts its dividend? ›
(2010), like Lie (2005b), suggested that their results “support the contention that a dividend reduction signals a drop in the value of a firm's growth options.” These results are consistent with the signaling theory, that is, cuts in dividends signal a lack of future growth/investment opportunities.
What does it mean when a dividend is reduced? ›
Dividend Cuts
These payments can be issued as cash or as shares of stock. A dividend cut occurs when a dividend-paying company either completely stops paying out dividends (usually a worst-case scenario) or reduces the amount it pays out.
What is an example of a dividend cut? ›
For example, consider a $20 stock with an annual payout of $1 (for a dividend yield of five percent) that cuts its dividend by 20 percent to 80 cents. If the stock plummets by 25 percent to $15, the dividend yield — despite the lower dollar amount of the payout — would actually be higher, at 5.33 percent.
What is the reason for decrease in dividend per share? ›
Some of the reasons a company's DPS may decrease include reinvestment in a firm's operations, debt reduction, and poor earnings.
What does a decreasing dividend per share mean? ›
A declining DPS may be due to reinvestment in a firm's operations or debt reduction, but may also indicate poor earnings and be a red flag for financial hardship.
Why are dividends disappearing? ›
The purpose of this article is to identify the variables causing the phenomenon of disappearing dividends. This is the decreasing probability of the issuer chooses dividend decisions (cash, stock, and mixed) rather than selecting the decision not to pay.
Part of the reason for "sticky" dividends is that firms are reluctant to cut dividends, because of the fear that markets will punish them. Consequently, they do not increase dividends unless they believe that they can maintain these higher dividends.
What big companies have stopped paying dividends? ›
List of All S&P 500 Companies with No Dividend
| Ticker | Company | 5-Year Sales Growth |
|---|
| CERN | Cerner Corp. | 117.71% |
| CHK | Chesapeake Energy Corp. | -32.34% |
| CHTR | Charter Communicatio | 302.60% |
| CMG | Chipotle Mexican Grill | 72.03% |
67 more rowsFirms pay no dividends due to cash constraints and investment opportunities. Firms do not pay dividends because of poor profitability and earnings. Firms avoid paying dividends due to the cost of raising external funds.
What happens when a firm cuts its dividend payout ratio? ›
Answer and Explanation: The correct answer is B. Earnings retention ratio will increase. Therefore, the lower the dividend payout ratio, the higher the earnings retention ratio.
What happens to dividends when stock market crashes? ›
There's two really important principles which make market crashes and dividends a great combination: Dividends depend on the business itself and how profitable it has been for that year. It is not linked to share price. This means that dividends are relatively stable.
What can investors learn from dividend cuts? ›
In an article titled 'Why companies that cut their dividend can be attractive income investments', Schroders provided what seemed like compelling evidence that as well as being a symptom of corporate distress, dividend cuts might be a real signal that the bottom has been reached, and a market rebound is about to start.
What happens to stock prices when the dividend is cut? ›
After a stock goes ex-dividend, the share price typically drops by the amount of the dividend paid to reflect the fact that new shareholders are not entitled to that payment. Dividends paid out as stock instead of cash can dilute earnings, which can also have a negative impact on share prices in the short term.
Why do stocks go down when dividends are paid? ›
It's no different for a company. Money that a company pays to shareholders is money that is no longer part of the asset base of the corporation. This money can no longer be used to reinvest and grow the company. That reduction in the company's "wealth" has to be reflected in a downward adjustment in the stock price.
