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This method is popular amongst firms in cyclical industries, as it allows them to curtail dividends during down cycles and reward their investors handsomely during up cycles.
The market analyzes stocks based on their returns, of which dividends are just one components. Dividend policy is considered to be a measure of a company's financial health, and a function of its business situation. The dividend is not considered important for investors in growth stocks, who view the company's business opportunities as being lucrative enough that free cash should be reinvested rather than paid out. Conversely, high dividend stocks, known as "widows and orphans" are considered to be companies in mature industries with steady income streams. The market's view is that there is little to be gained for such companies to reinvest their earnings. Because of this, the opportunity for capital gains is limited, and investors will require the certainty of a dividend payment to justify investing.
If dividend policy is viewed in certain ways by the market, for management it is viewed as a way to send signals to the market. An increase in dividend, for example, shows confidence on the part of management in the firm's future cash flows. This is especially true for companies that are declaring their first dividends - this is management's way of signaling that the company is maturing and has arrived at a stable place in the business world.
Management is...
Normally, an earnings warning will suffice in advance of poor results or troubled times. A decrease in an otherwise stable dividend is considered one of the strongest negative signals a company can make to the market. This is because a dividend reflects not only today's business situation but reflects on the situation for years to come. A decrease in dividend is viewed by both management and the market as signal that the firm's future prospects have worsened to the point where the problem is no longer to be viewed as temporary.
Some prominent companies do not pay dividends. Despite their size and apparently stable revenue streams, these firms believe that they have sufficient investment opportunities that their shareholders would benefit more from the firm seeking those opportunities rather than receiving a cash payment. Among the firms that do not pay dividends are such prominent high tech stocks as Amazon.com, eBay, Google, Sun Microsystems and Yahoo. Each of these is operating in an environment that is growing, nascent and wildly unstable, hence why none feels comfortable enough to issue dividends.
Bibliography
No author. (n.d.). How and Why do Companies Pay Dividends. Investopedia.com. Retrieved June 18, 2008 at http://www.investopedia.com/articles/03/011703.asp
Dividend payment information from Reuters. http://www.reuters.com/finance
Bibliography
No author. (n.d.). How and Why do Companies Pay Dividends. Investopedia.com. Retrieved June 18, 2008 at http://www.investopedia.com/articles/03/011703.asp
Dividend payment information from Reuters. http://www.reuters.com/finance
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