Are Dividend Distributions So Important?

Dividend distributions are a distribution of a company's profits to stockholders. The company's Board of Directors will declare a dividend, usually each quarter, based on the profits.

Dividends are not an obligation. The company can choose to change the dividend payout for any number of reasons. For example, a company experiencing increased profits may choose to maintain its dividend payout at its current levels and use the extra profits to invest in the company by expanding operations, building new facilities, or buying another company. Or, the Board of Directors can choose to raise the dividend payout to its shareholder if it believes this is in the best interest of the company and shareholders. Conversely, the Board may need to reduce or eliminate dividends if the company is undergoing financial distress, or if they company needs the profits to sustain operations. No profits, no dividends.

Changing its dividend payout sends a huge signal to investors. Companies typically do not like to reduce dividend payouts because it is taken as a sign to investors that the company is undergoing hard times. Raising its dividend payout signals either of two things. Either the company is growing its profits and is so confident in that growth that it is willing to give more of it to shareholders since the likelihood of having to later reduce the dividend distribution is unlikely. Or, it could be a signal that growth is maturing, the company doesn't believe it needs the profits to grow the company, so its best use of profits is to distribute it to the shareholders.

Companies manage dividend distributions very, very carefully because they send important signals to investors.

There are many companies that called "Dividend Aristocrats" because they have raised their dividends every year for over 25- years. Does that automatically make a Dividend Aristocrat a good candidate for your dividend portfolio?

No.

Good dividend stock candidates are ones that have good valuation ratios. They have to demonstrate not only a good (but too high) dividend yield, and an ability to increase dividend payout every year. You must also look at how much the dividend payout is increased each year, how much opportunity the company will have to raise its dividend payout in the future (called the payout ratio).

Equally important is how cheaply the stock is valued compared to its stock price. Valuation ratios that you should look at include: Price to Sales (lower is better), Price to Earnings (lower is better), Free Cash Flow (higher is better), and debt (lower is better).

There are several Dividend Aristocrats who have made the list because of carefully managed dividend distributions, but the stock valuations make the stock a poor investment choice.

Where To Find Dividend Distribution Information

My favorite is Yahoo! Finance. Just type in the stock’s ticker symbol and click on “Key Statistics” in the left column navigation pane. It will give you dividend rate, dividend yield, payout ratio, dividend date, ex-dividend date, and any stock splits.

You can also click on the company’s Cash Flow Statement and see that dividend distributions are subtracted from a company’s cash flow stream. A company paying dividends while experiencing a negative cash flow is a huge red flag because this means they are paying dividends from their cash reserves or from borrowing. This is unsustainable and will probably mean they will cut their dividends in the future.

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