Why Do Companies Increase Dividends? (7 reasons)

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It’s A Good Sign When Companies Are Increasing Dividends

Continuing with our dividend Q&A series, today we are discussing the question: why do companies increase dividends?

I don’t know about you. But as a dividend stock market investor, I love when a company announces a dividend increase.

So, let’s kick around exactly why a company chooses to do so…

7 Reasons Why Companies Increase Dividends

Companies pay increased dividends to:

Share higher profits with investors
Maintain dividend growth record
Send positive signals about company prospects
Provide support for the stock price
Maintain existing investors
Attract new investors
Manage changes in the business growth profile

Next, let’s dig deeper into each of these reasons. Then you will know exactly why companies raise their dividend rate per share…

Why do companies increase dividends? — Reviewing my dividend growth stocks

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And before you go, be sure to check out…

All of our Dividend Q&A Articles

We have more than 100 posts related to dividend growth investing. A little something for every good dividend investor!

But now, a discussion of the 7 reasons why companies increase dividends…

1. Share Higher Profits With Investors

Dividend payments are the most direct way a company can share profits with its owners. They do this by establishing and maintaining a dividend policy.

For example, many companies determine a percentage of earnings that will be paid to shareholders each year in the form of stock dividends. This is known as a dividend payout ratio.

Then, as profits rise. The company increases its dividend rate per share.

By doing so, they maintain their dividend payout ratio at a consistent level. In most cases, management does this by increasing the dividend rate annually.

Leading me to the second reason why companies raise their dividend rate per share…

2. Maintain Their Dividend Growth Record

Elite dividend-paying companies that regularly increase their dividends receive recognition from the investment community.

First, one of the most well-known accomplishments is being recognized as a Dividend Aristocrat. Dividend Aristocrats are S&P 500 companies that have increased their dividend rate per share for at least 25 years in a row.

Furthermore, there are also Dividend Kings. Representing companies having increased dividends for at least 50 years in a row.

Finally, we have the Dividend Achievers. They are the up-and-comers. Being companies with a minimum of 10-year dividend increase records.

Once a company establishes a dividend increase track record. Leading to recognition as an elite dividend growth stock.

Then management is resistant to losing that status. Since they have worked long and hard to achieve it.

Thus, they continue to raise the dividend every year. Even during difficult economic times.

Here’s the third reason that a company may boost its dividend…

3. Send Positive Signals About Company Prospects

First of all, by announcing and paying a higher dividend rate, management is sending positive signals to its stakeholders and competitors. This is one of the advantages of increasing dividends.

Furthermore, the act signals that the company is having financial success. And management believes that success is likely to continue.

Finally, a company’s dividend hike makes shareholders feel good. Since it confirms they own a stock providing a rising stream of dividends.

Next up, is the number four discussion point about what a growing dividend means…

Understanding increasing dividends — Lovin’ my dividend increases

4. Provides Support For The Stock Price

A higher stock price is another way a company rewards its investors. Since the combination of dividends plus capital gains provides an investor with an attractive total return on investment.

Now, you might be asking, how do dividend increases support the stock price? Here’s how…

First, a higher dividend increases a stock’s dividend yield. Calculate dividend yield by taking the new higher annual dividend rate per share. And dividing it by the stock’s price.

The dividend yield is a closely followed metric by investors. If a high-quality company has a higher dividend yield.

Either due to a falling current share price. Or, an increase to the dividend rate. The two causes of an increasing dividend yield.

Typically, investors are more inclined to buy the stock. Thus, supporting the stock price.

Second, as I mentioned earlier, increasing dividends are often paid because of higher profits. And profits are another closely watched measure of company performance.

Over the long run, higher company profits are closely related to a higher share price. With capital gains being the result. History tells us this is true.

Next up, is another reason why companies raise their dividends…

5. Maintain Existing Investors

And this reason for rising dividends hits close to home for me. For the dividend growth stock investments that I currently own.

Because when I hold a company’s stock. One of the first red flags that gets me to think about selling is this…

When a company routinely raises its dividend during a specific time of the year. But does not do so. And leaves their dividend rate constant.

Typically, when a dividend is not increased. At the time it always has been increased. It is an early sign of financial trouble.

Prompting investors like you and me. To think seriously about selling our shares.

A rising dividend also serves to…

6. Attract New Investors

As a company racks up dividend increases year after year. New investors will take notice and initiate positions in the stock.

Thus, increasing dividends also attract new investors. For example, there are index funds tracking dividend growth stocks.

And dividend mutual funds that emphasize Dividend Aristocrats in their portfolio holdings. Thus, when a company achieves Dividend Aristocrat status. It either requires or at the least encourages new investors to consider investing in the stock.

Last but not least, the final reason for dividend increases…

7. Manage Change In The Business Growth Profile

An investor should not consider dividends to be free money. Because companies, even those with stocks that pay dividends, have options when deciding what to do with their cash flow.

For example, a company with rapid growth prospects may choose to reinvest all cash back into business investments. Thus, choosing to use cash for internal growth investments versus paying a dividend.

On the other hand, most businesses travel through a life cycle. From start-up to growth, through maturity. Furthermore, as a company matures, attractive internal investment opportunities are more difficult to find.

Thus, management decides to return more cash to shareholders in the form of dividends paid. Rather than allocating that cash to sub-par internal investment opportunities.

Okay. That concludes today’s dividend Q&A about companies boosting their dividends. And why they do so.

Allow me to wrap up with a few parting thoughts…