It’s a good day when you learn that a company in which you own stock will boost its dividend. A dividend boost occurs when a company pays a higher dividend than it did in the past. A dividends is a distribution of a company’s profits to shareholders. An increase in dividends results in more money in your pocket and can have various effects on a stock’s price.
The Decision to Boost
A company chooses how to spend its profits, just like you decide how to spend your leftover cash after paying bills. A company can reinvest profits into its business or distribute them as dividends. The decision to raise a dividend requires careful consideration because the extra cash will no longer be available for other uses. Also, shareholders might expect the new level of dividends to continue. If a company fails to keep the higher payments coming, angry investors might abandon their shares.
Investors try to interpret a dividend boost to gauge a company’s future. A dividend increase is typically a sign of improving financial strength similar to buying a new car when you get a raise. A company that boosts its dividend is sending a message that it has extra cash and is confident about its future profits and cash flow. For example, if a company boosts its quarterly dividend by 30 percent, it is probably financially sound.
Declining Growth Opportunities
Although a dividend boost suggests a company has a strong bank account, the increase might also suggest that a company has fewer investment opportunities on which it can spend its cash. Dividend increases typically come from mature companies that are established in their industries. Young companies experiencing rapid growth rarely boost their dividends -- if they pay one at all -- because they must reinvest their profits for expansion.
Effect on Stock Price
Investors might bid up a company’s stock price when it announces a dividend increase if they believe the company is using its cash wisely. The higher payment can spark demand from existing investors and might attract new investors, such as mutual funds that hold dividend stocks. Investors might punish a stock’s price if they believe a company should reinvest its money in its business. For example, a high-growth company entering new markets might hurt its stock price if it raises its dividend.