Dividends are a part of profit distributed to investors every year. You can read and understand a lot about a company from their dividends.
Here are five important takeaways:
Dividends can be a sign that your company is profitable. This is because a company it cannot distribute money to its investors unless it is profitable. Secondly, it can only increase its dividend payments if it is becoming more profitable. In contrast, a fall in dividends can also show that all is not well with the company.
You can make out from a company’s dividend policy if it is in the growth stage or if has reached its stable point. If a company’s dividends grow consistently over the years, it means the company is growing. However, a company cannot keep growing at a fast pace forever. After a certain point, the company’s growth stabilizes. The company’s dividends grow at a slower pace too. Such companies are often considered to be blue-chips. The dividends also serve to remind you that the company is likely to be stable in the future.
In the initial years, companies prefer to use the profits for operations or a new project rather than distributing as dividends. This is why a lot of young companies give lower dividends while mature companies give higher dividends. So, the management decides what the best use of the profits is. A dividend, thus, means that the company does not have a better use for the money. It also means that dividends are the best return possible for investors.
The above theories can be put to test only for a consistent dividend policy. And when this consistent policy changes, investors should take notice. Usually, companies rarely stop paying dividends suddenly. In times of trouble, companies usually announce a reduction in dividend payments. In such cases, you may want to check why the company decided to do so. It could be because of a temporary downturn in the economy. However, it could also be a sign that the company is under financial distress. You may often notice a fall in share prices after such announcements. It is important that you recheck the company’s future prospects.
Dividends can be either in cash or stock issues. Sometimes, companies choose to use profits to buy back stocks. Buybacks usually represent a company’s confidence. The idea is that promoters, like other investors, want to hold stocks of good companies too. So by buying stocks of their own company, they indicate their confidence. This is why buybacks usually lead to a rise in the price. This is unlike dividends, which are followed by a fall in stock prices. However, if a stock has been falling for a long time, a buyback could be a flimsy way of trying to stop the fall. In this case, investors may prefer getting cash in hand from dividends.
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