Understanding Dividend Decisions: Why Some Companies Don't Pay Dividends

Dividends are income for the investor, but not all companies pay out this way to shareholders

Many investors look at dividends as an important part of an overall investment strategy, and they absolutely should. Stocks that pay dividends put income into the investor's pocket, and many established companies raise the dividend each year. Some companies, however, do not pay dividends, and what follows are some common reasons why:

Not Profitable

Dividends, by definition, are paid out of the profits of the company. If a company is just breaking even or losing money, paying dividends might put it at risk of failing.

Cash-Flow Restrictions

Even if a company is generating a big profit, it may lack cash to pay dividends. A lot of the cash the company has may be reserves for big capital expenditures, paying down debt, or a big lawsuit settlement. Some companies borrow funds to pay dividends, but that is not a sustainable practice.

Contractual or Regulatory Reasons

Some companies are forced to cease dividend payments due to lender or even government entanglements. Banks, for example, cannot pay dividends if they are losing money. A big lender may not loan a company money unless dividend payments are reduced or eliminated, as the lender wants to be sure the company can first pay back the loan. Under the Troubled Asset Relief Program, or TARP, for instance, such restrictions on dividend payments were imposed on banks that borrowed from the government.

Preference to Retain Earnings for Growth

When the company pays dividends to shareholders, there is less in the company's coffers to grow the business. If management feels it can better use the cash to invest in new business opportunities to grow the company, it will be hesitant to pay out profits to shareholders.

Tax Reasons

Dividends are taxable income events for the investors. Companies that pay dividends have already paid taxes on the income at a corporate level, and once the dividends are paid out to shareholders, the government takes another cut. This is particularly a concern in companies where dividends have never been paid and there would be a significant tax liability for larger shareholders.