---
title: "Why Do Companies Pay Dividends?"
description: "Why do companies pay dividends? When does a company issue dividends, and what does quarterly income mean for your investments?"
canonical_url: https://trendshare.org/how-to-invest/why-do-companies-pay-dividends
markdown_url: https://trendshare.org/ai/why-do-companies-pay-dividends.md
published: 2013-10-05
last_updated: 2019-09-03
content_license: https://trendshare.org/about/disclaimer
---
# Why Do Companies Pay Dividends?

Source: https://trendshare.org/how-to-invest/why-do-companies-pay-dividends
Updated: 2019-09-03
Suppose you own a share of stock in Canada's Best Lemonade Company. Your
grandparents bought it for you when you were born, and you've held it ever
since. It's a good company. It's made money every year. Four times a
year—once a quarter—it sends you a check. At first it was 10 cents
a check. Then it went up to 11 cents and then 12 and now that you're 21 years
old and out on your own, you're making a whopping 31 cents every quarter from
the single share of stock you own.

What is this and why is it happening?

## What is a Dividend?

This is a dividend. Your friendly Canadian lemonade company pays a dividend
for one or more reasons:

- To return profits to shareholders

- To demonstrate financial strength

- To attract investors

As explained in [What is a Stock Dividend](https://trendshare.org/how-to-invest/what-is-a-stock-dividend), a dividend is a portion of the company's profits that you as a
stockholder are entitled to. You own one share, so you get to that tiny
percentage of whatever the company earned. That's a little check sent to you
every three months.

Suppose your grandparents on the other side bought you a share of stock in
Europe's Best Bagel Company when you were born, but that company has never ever
ever sent you a dividend check. It might not. It doesn't have to. ([Some companies never pay dividends](https://trendshare.org/how-to-invest/why-do-some-companies-not-pay-dividends).)

## Dividends are Shareholder Profits

A company can do a lot of things with its profits. It can reinvest them in
the business by expanding into new markets or geographic areas. Perhaps it
makes sense to lease retail space in malls from Prince Edward Island to the
wilds of Vancouver, BC to put up lemonade kiosks, but maybe it doesn't make
sense this year (mall space is too expensive this year or the market's
currently hotter for bubble tea and lemonade would be confusing).

A company could instead decide to buy other companies. Maybe the bubble tea
fad burst and all of the bubble tea shops are going out of business, but you
could buy one of them at a huge discount and sell bubble tea to people who
really love it (the market isn't entirely going away). Then again, maybe there
are no good acquisition targets.

A company could invest the money in other financial instruments, such as
bonds or, well, other stocks. That's risky, though, and how does the board of
directors know that it'll make better investments than shareholders could make
on their own?

A company could keep the cash on hand, just in case something unexpected
happens. Better to have a nest egg (can a corporation stuff a few million
dollars under a mattress?) than to not.

If none of these options make sense, the board of directors might decide to
return some of those profits to shareholders. That's your dividend check, right
there.

You can see this by looking at when companies announce dividend payments:
generally at the same time they announce quarterly earnings. If profits are
coming in as expected, you'll see dividend-paying companies reiterate their
quarterly payments—and sometimes increase them.

## Financially Strong Companies Pay Dividends

To pay a dividend regularly, a company must have a consistent business
model. It can't be in the habit of losing buckets of money every year. It has
to bring in money, and it has to make a *profit*. If everything else is
equal, [it's better to own shares of a company that reliably makes money](https://trendshare.org/how-to-invest/earnings-matter-most) than a company that doesn't.

Paying a dividend reliably is a sign of the business's strength. Risky
businesses can't pay reliable dividends for long.

## Dividends Attract Investors

Paying a dividend can attract a different type of investor, one less
interested in speculation and quick turnaround. Some people—especially
retirees or people otherwise living off of investment income—rely on
quarterly dividend checks the way workers rely on paychecks. These investors
*could* perhaps make more money investing in growth stocks, not dividend
stocks ([dividend yield](https://trendshare.org/how-to-invest/what-is-dividend-yield) is rarely the 8%
you might expect from the [S&P 500 index](https://trendshare.org/how-to-invest/buy-the-s&p-index-fund) over time), but they want the reliability of this quarterly income.
(This strategy from high dividend paying stocks might lead to less volatility
of the stock's price, but that's hard to measure.)

Truly successful dividend stocks often *raise* their payout
regularly, as in the case of the Canadian Lemonade stock. Sure, going from 10
cents per share to 12 cents per share over a couple of years doesn't sound like
much if you only own one share, but a company that can return 20% more profit
to its investors over a couple of years is doing something very, very right
(and very, very attractive). When companies pay dividends every three months
and raise the amount they pay, you've found successful businesses.

## A Failing Company Might Attract More Investors with High Dividends

If you're chasing the highest dividend paying stocks, watch for one danger
sign. A company in financial trouble might suddenly announce out a very
attractive dividend to try to attract new investors and increase its stock
price. (If the company wants to issue more stock, this could be a mechanism to
improve the expected amount of money raised by issuing that stock.) You can
spot this case pretty easily, however: a company that's never paid much out
suddenly offers an attractive dividend.

What's the catch? Ask yourself if you can expect to get a similar check next
quarter and the quarter after that and so on. You'll avoid heartache.

## Dividends are Nice, But They're Not Essential

Dividends aren't the only reason to hold stock. Sometimes it makes sense for
an up and coming company to invest all of its profits back into the business.
Other times it makes sense to grow by acquiring other companies. Yet holding
bushels of cash (in the case of [Apple Computers](/stocks/AAPL/view), for example, billions of dollars in reserve) makes investors
wonder why they're not getting their cut of the profits. (See [Should Apple Pay a Dividend?](https://www.forbes.com/sites/investor/2012/02/10/should-apple-pay-a-dividend/) from before Apple announced its payout.)

Investors expect their investments to grow, so the companies they hold need
to continue to make money. Whether the profits they make get reinvested in the
business or returned to shareholders as dividends, those profits belong to the
shareholders. *Why do companies pay dividends?* Because the board of
directors believes the best way to return this money to the shareholders is in
those nice quarterly checks.