Any dividend-focused investor would probably claim that dividend-paying companies have more stable and resilient share prices compared to companies that don’t pay a dividend. However, is there any basis for this claim, and do dividends really provide clues as to how share prices move?
Investors who consciously choose to focus their attention and portfolio allocation on dividend-paying stocks generally look for specific attributes such as stability, resilience, and predictability. Share prices are as much as a function of the fundamental attributes of a company as they are of the sentiment toward its future business prospects.
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So, let’s explore a few aspects of dividends and how they can provide signals on share prices.
Higher dividends lead to a higher share price
There is a direct correlation between the amount of dividends declared and the share price, as investors view a higher dividend as a signal that the company’s business is performing better. This is true in most cases: When businesses do well, they are often willing and able to increase the dividends they pay out. This results from having higher profits, which would then eventually translate into better cash flow.
Companies that pay more dividends may also be signaling better prospects ahead, which provides them with the confidence to pay out more. Investor sentiment toward the company would be positive as a result of the signaling, which also leads to more investors bidding up the share price.
Share-price resilience during tough times
During tough times, companies that have historically been able to consistently and regularly pay dividends also see much lower volatility in their share prices. Dividend-paying companies usually have strong balance sheets and superior cash-flow-generation capabilities, thus rendering them more resilient during an economic downturn.
While no company is totally immune to bad times, companies with solid financials and an enduring business moat should be able to weather the storm better than companies with excessive debt or an outdated business model.
The Foolish takeaway
Dividends do indeed send a strong signal to the market regarding companies with stable operating characteristics and resilient business models. Investors should therefore actively search for companies that pay consistent, growing dividends, as this should translate into better share-price performance during good times and lower share-price volatility during bad times.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.