Understanding Stock Dividends: How Companies Decide

Companies determine stock dividends in a number of ways. Some of the important factors include how much was earned, what the company has paid in the past, future cash needs and the message the company wishes to send to the market. Each of these plays a role that you should consider.

Dividends are paid out of a company’s earnings. The amount that the company earns in a given year or quarter, therefore, is of central importance in determining how much to pay investors. The company must weigh its income against future needs to determine how much of its earnings to distribute. Retained earnings--the cash not paid to investors--is one of the sources of a company’s operating capital.

Another important consideration is how much the company has paid in the past. Major shifts in dividend policy can signal either positive or negative news to the market. For this reason, a company may maintain its dividend even when it projects higher cash needs so as not to send a weak message to investors and the market. As many investors judge a company by its dividend history, many companies are very careful in managing expectations through dividends. As an investor, you should consider each of these factors when analyzing a stock.