When investors want to invest in dividend stocks, they usually conduct stock analysis to determine which stocks or which companies pay more in the form of dividends. If a company pays more in dividends, many investors will want to buy the company’s stock. But can paying higher dividends make companies attractive investment options? Surprisingly, not all investors including the corporate financial strategists agree to this. In corporate finance, one of the most extensively circulated propositions is that a dividend is neutral and hence cannot affect an investor’s returns. But how is this even possible?
If a company implements a policy of paying more in dividends quarterly, bi-annually or annually, say 5% of its stock price instead of 2% it is currently paying, does this not increase an investor’s total return? Apparently, this is not always the case. This is because the anticipated appreciation in price of the company’s stock will fall by precisely same amount as its dividend increases, say from 8% to 6%. This will leave an investor with an overall return of less than 10%. Although this view is adhered to by many people, other theorists disagree with it by stating that a company may indicate its increased confidence in future earnings through increasing its dividends hence making dividend investing interesting to investors.
Accordingly, the stock prices will also increase when the company increases its dividends and will drop when the company cuts its dividends. Generally, investing in dividend stocks will always carry with it some risks, especially if an investor invests in a company that pays higher dividends. In fact, some investors avoid investing in dividends because they expose them to higher taxation rates. Higher taxes simply reduce the value of the dividends. Therefore, a dividend can decrease, increase or have no major effect on value. This will however depend on which argument an investor subscribes to.