Buying stocks that don’t pay dividend

QUESTION: How many stocks on the Jamaica Stock Exchange do not pay dividends? Should prospective investors buy these stocks? — Oconnor

FINANCIAL ADVISER: Dividends are payments from the profits of a company to its shareholders. They are recommended by the directors, but it is the shareholders who ultimately vote for the dividends to be paid, that is, they approve the payment of the dividends at annual general meetings. The company, however, has no contractual obligation to pay dividends.

Although many companies tend to pay an annual dividend, there are others that pay more frequently — twice per year or even more. Dividends are paid to shareholders on the shareholders’ register of the company on what is called the record date.

There is a designated period during which the stock trades ex-dividend, that is, investors who buy stock during that time are not entitled to a dividend. Currently, that period commences two business days before the record date and extends to the payment date.

Dividends are declared per unit of stock and are paid on the amount of stock that each shareholder owns at the record date. If, for example, the dividend on stock ‘LMN Limited’ was 50 cents per stock unit and you owned 10,000 units of the stock, your dividend would be $5,000.

There is no need to wait until a dividend is likely to be paid to buy stock. In any event, stock prices often increase just before a dividend is paid, giving no advantage to the new shareholder, while not putting the seller at a disadvantage.

There are cases in which arrangements may be made to reinvest dividends. In such cases, the shareholder may sign a mandate authorising a broker to use the dividends to buy additional shares in the company that paid the dividends.

Dividends belong to you, the shareholder, and you are free to use the funds as you please. The funds are paid by cheque by general practice, so you may lodge your dividend cheque to your account, invest the funds, or spend them.

Dividend rates tend not to be high, one reason being that many companies opt to retain profits, which explains why there is a line in the balance sheet called retained earnings or retained profits; these are shareholders’ funds.

This serves to lessen the need for the company to borrow and also gives it more resources to invest thus strengthening the financial position of the company as well as enhancing its position to be more profitable in the future. This, in turn, raises the prospects for the price of the stock to increase at a faster rate, so the investor really postpones an immediate benefit for a longer term benefit.

Although at today’s prices dividend returns are relatively low, investors who bought stock many years ago do make good dividend returns in many cases. By policy, some companies distribute a set portion of their earnings as dividends so the dollar value of dividends increases as earnings increase, but there are companies which adopt a conservative dividend policy — whether it be in terms of a fixed dollar amount or as a percentage of profits.

The following are the main factors that determine if a company pays a dividend.

Net earnings for the current financial year

Stability of earnings over several years

Amount of retained earnings and the rate of return thereon Working capital position Plans for expanding or contracting operations

Restrictions in the trust deed of outstanding bond issues or preferred covenants which may require working capital at a certain level before dividends are paid

Policy of the board of directors, who are guided primarily by the goals set for the company

It is up to you if you want to get good dividend income from your equity investments or if you prefer to bank on capital appreciation which may come from strong earnings growth to which high levels of retained earnings may contribute.

If companies pay low or no dividends because of poor earnings, then there is good reason for not investing in them.