Your company has shown a net profit over the last few years. While the number of

Question

Your company has shown a net profit over the last few years. While the number of shareholders has grown during the years your company has never paid any dividends. The company treasurer would like to consider paying out dividends.   First discuss, what it means to pay out dividends. Discuss when it is a good idea to pay dividends and when it isn't. Also, what concerns should you address related to future growth of your company if you pay out dividends to stockholders? Does it signal that the company is necessarily doing well?

Explanation / Answer

If there are no dividends, how is an investor supposed to make money by owning a piece of the company? The only other way to making money as a stockholder is to sell your stock at a higher price than you bought it, either because other "investors" want it desperately to pay more, or because some other company will try to acquire the company's stock by paying a high price for shares. This investment strategy means you are ipso facto not interested in being a long-term owner of the company, but instead are gambling on a secondary market -- that of the stock itself -- which is only loosely correlated (if at all) to the actual performance of the company.

So to answer your original question: the company may wish to encourage that kind of long-term thinking on the part of investors and management, and they may think that they are unable to make the stock price rise indefinitely, so dividends are the primary way they can encourage investment but mostly it is to increase shareholder value. The basis among mature companies is that there is no more growth to pursue and the companies in question sit on excess cash flow and low levels of debt, if not no debt at all. In such circumstances, the companies pay out dividends. Also, the companies without a dividend history are typically viewed favorable when they declare new dividends.

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