Dividend Increases and Cuts

Check out the introductory post on dividends if you haven’t already done so.

If you own a stock that pays a dividend then you want the dividend to increase over time.  A $4 dividend now will not be worth much in 15 years because of inflation, so ideally the dividend increases should at least match the inflation rate.  The best dividend stocks to own are ones that increase their dividend every year at an amount greater than inflation.  Coca Cola is an example of a company that has a long history of increasing its dividend every year.  Companies that increase their dividend every year for long periods of time are known as dividend aristocrats.

Dividend cuts

A company will pay out a dividend from its cash reserve so if the company is not making much money then it might reduce the amount of the dividend or even remove it altogether.  While this is not good news for shareholders, it is often better for a company to conserve its money (by cutting a dividend) rather than go bankrupt.  If the company can get back on its feet again, then it can resume the dividend payments.

A recent example of a dividend decrease is Bank of America.  This bank has run into a number of problems related to sub-prime loans so rather than continue to pay out the normal dividend and risk running out of cash, the company decided to decrease the amount of dividend.

Dividend suspensions

The worst case scenario of a dividend cut is when the company stops paying it out completely.  General Motors is a company which is having major financial problems and suspended their dividend.

Effect on stock values

Changes to stock dividends will often affect the stock price – if the dividend increases then the stock may go up and vice-versa.