Honey Money: Why Companies Bother With Tiny Dividends

Kristin Orman By Kristin Orman, Research Analyst, The Oxford Club

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From the Mailbag:

I’ve noticed a lot of stocks pay miniscule dividends. Some rather large companies have dividend yields of under 1%. My question is, why do they even bother? What’s the point of paying shareholders a few pennies each quarter?

Investors love dividend-paying stocks almost as much as Winnie the Pooh loves honey. And most companies have heard the buzz.

The vast majority of the companies included in the S&P 500 reward their investors with cash dividends… 425 companies to be exact. But 61 of those companies sport dividend yields of under 1%. And 20 of them yield just 0.5% or less.

In a few cases, they pay investors less than $0.10 a year. The trouble and expense of declaring and then cutting all those checks hardly seems worth it. Still, many companies do it. The reasons why may not be so obvious to investors.

Let me show you…

Besides managing their businesses, most public management teams are also charged with managing their stocks and their stock prices. The easiest way to do that is to get people to buy it.

It’s hardly a secret that investors, large and small, are attracted to stocks that pay dividends. Public companies want these investors as shareholders.

Income investors are more valuable shareholders to a company because they typically hold its stock longer. If the stock price sags, the dividend eases the pain. They are less likely to sell – and drive prices down further – if the market drops.

Plus, those who don’t need the money right away enroll in dividend reinvestment plans and buy more shares. This results in a more stable investor base and a less volatile stock price.

Buyers of dividend stocks are typically different from those who buy growth or momentum stocks. They are not as interested in speculation or day trading. That’s why the stock prices of dividend-paying companies tend to be less volatile. Many of their shareholders are in it for the long haul.

Additionally, a lot of institutional investors are mandated to invest in only dividend payers. It does not matter how large or small the dividend is, just that the stock pays one. Institutions like large mutual funds buy lots of stock. Having them listed as shareholders adds credibility to the business and attracts investors who like to follow the “smart money.”

On the other hand, sometimes dividend yields fall because business is not going well and the company is forced to cut its dividend to survive. Many banks, like Citigroup Inc. (NYSE: C), had to chop and eventually eliminate their dividend payments as a result of the 2008 financial crisis.

More than two years later, in 2011, Citigroup reinstated its quarterly dividend. The shareholders’ reward? A miserly $0.01 per share. After accepting bailout money from the Fed, a penny was the maximum Citigroup was allowed to pay.

It was mostly a symbolic gesture to shareholders, but many analysts on the Street speculated that the meager dividend was reinstated to broaden Citigroup’s shareholder base. It would allow income-oriented mutual funds barred from purchasing stocks that don’t pay dividends to invest in the company. They were probably right. These same analysts expected Citigroup to substantially raise the dividend in the following years. It didn’t.

During rough business or economic patches, distributing cash to shareholders can also signal that management expects strong future cash flows. It may also show that the company prudently saved a significant amount of cash in case of a hiccup. A dividend, even a small one, can help soothe nervous shareholders.

Initiating a small dividend is a quick and cheap way for a company to open up its stock to a whole new group of investors. It is also a sign that business is going well. Finally, the message a dividend sends to investors is pretty clear: Management believes the future looks bright.

Good investing,

Kristin