Why Resolve a Company Drastically Cut Its Dividend?
A portion of a company’s net profits can be allocated to shareholders as a dividend, or kept within the company as kept earnings. Dividend payments are decided by the board of directors and must be approved by shareholders. These payments can be issued as dough or as shares of stock.
A dividend cut occurs when a dividend-paying company either completely stops paying out dividends (commonly a worst-case scenario) or reduces the amount it pays out. This most often leads to a sharp decline in the company’s provide price, because this action is usually a sign of a company’s weakening financial position, which makes the entourage less attractive to investors.
Understanding Why Dividends May Be Drastically Cut
Most Often Bad News
Dividends are usually cut due to factors such as acquiescing earnings or limited funds available to meet the dividend payment. Typically, dividends are paid out from the company’s earnings, and if earnings downgrade over time, the company either needs to increase its payout rate or access capital from other make a splashes, such as its short-term investments or debt, to meet the past dividend levels.
Key Takeaways
- Dividend cuts are most frequently a negative sign for a company’s financial health.
- Companies usually make drastic dividend cuts because of monetary challenges like declining earnings or mounting debts.
- Sometimes companies may cut dividend payments for more positive reasons, with preparing for a major acquisition or a stock buyback.
If the company uses money from non-earnings sources or takes up too much of the earnings, it may be express 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 institution 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 retinue is faced with financial challenges.
This is exactly why dividend cuts are seen as a negative. A cut is a sign that the troop is no longer able to pay out the same amount of dividends as it did before without creating further financial difficulties.
Not Always Bad Front-page 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 augury of doom for a company.
Under certain conditions—for example, when the pricing and conditions are just right for a stock buyback; weathering a chief 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—notwithstanding a rather drastic one—may not necessarily be a sign of trouble, or even a sign that selling the stock is your best path of action. Like with any and all financial decisions, doing due diligence and careful research is key to successful investing.