HomeBusiness DigestWhy companies do not pay dividends

Why companies do not pay dividends

By Paidamoyo Dziwa

INVESTING in shares of listed entities, usually on exchanges such as the Zimbabwe Stock Exchange (ZSE) or the foreign currency denominated Victoria Falls Stock Exchange (VFEX) is one of the options that many individuals, corporates, pension funds as well as other institutional investors have been making use of.

The advantage of this form of investment is two-fold as one will derive growth in the portfolio as the value of shares increase (not always guaranteed though) and in addition one can also get some dividends paid out to them. The first reason has been a major driving force for those with excess funds particularly in local currency to invest on the stock market. Analysis has shown that the ZSE has outperformed any other market including the parallel market.

The second reason why one would choose to invest in the listed counters would be dividend pay-outs. Currently, we have seen a number of listed entities release their half-year results and some have declared dividends, particularly in the financial services sector.

However, some entities have not declared any dividends and this article attempts to shed some light on some of the considerations companies make in arriving at the decision on dividends declarations.

General considerations

Before payment of a dividend, directors weigh the advantages of spending cash to pay dividends against other factors such as:

  • The dividend policy of the company, for an example, some companies pay every two years or when a certain profit margin is achieved.
  • Reinvesting money back into the business to finance growth within or via acquisitions.
  • Meeting debt financing requirements.
  • Investor expectations.
  • Meeting unexpected expenses.

In some cases, however, non-payment of dividends may be a signal of a struggling entity which is in financial distress and facing cash flow problems. A company may report a profit in its financial statements but fail to generate cash hence the inability to pay dividends.

 Covid-19 specific considerations

The ongoing pandemic has had negative impacts on the entire world. During 2020, the pandemic disrupted most companies and hurt their revenues and profitability. During 2021 there has been an adaptation to the current environment as some growth has been noticed.

Apart from the other changes brought about by Covid-19, entities have been forced to re-examine their norms around dividends of late. The uncertainty that still subsists has resulted in a conservative approach being taken even though an entity might have started recovering and growing as the vaccines are rolled out and the lockdowns are eased.

The manner in which Covid-19 has behaved, i.e. in the form of numerous waves, requires entities to decide on the issuance of a dividend with a view on a likely response should a fourth wave come. Financial resilience must be built up to allow weathering of any further waves that might occur.

Dividend suspension or deferral

When a company does not pay dividends, this is cash saved. Depending on the financial circumstances of the company, this may imply that the company has adequate resources to pursue its earmarked projects and thus does not need to seek debt financing, which is both risky and expensive.

Companies thus finance their projects in a cost-effective manner. The avoided interest, legal fees, establishment costs and so on are a potentially huge saving by the organisation.

For a company in financial distress and facing cash flow or working capital challenges, not paying dividends reduces the financial burden. This will increase cash available to meet critical expenses and increase the entity’s chances of survival.

This will ultimately serve the organisation well as it may then be able to pull itself out of the distress and thus reduce negative impacts on stakeholders such as employees, creditors, customers and of course the shareholders.

Not paying dividends also increases the value of the statement of financial position (balance sheet), leading to increased value of the company. A strong balance sheet also assists entities to access other sources of financing as well as attracting more investors or partnerships.

Impact on shareholders

Where no dividends are not declared, shareholders such as pension funds and pensioners will be deprived of income. The immediate impact to shareholders is that their disposable income will be reduced.

At times when companies do not declare dividends, share prices go down. This may be triggered by a perceived lack of attractiveness of the specific counter and hence the dumping or offloading of the shares of the particular entity by the shareholders.

In the long-term, however, if the company opts to reinvest for growth, the shareholders will benefit as the company grows in value and the share price increases (capital growth).

As the company grows, the expectation will be that it will be able to generate more revenue and more profit with greater economies of scale which will translate to more dividends for shareholders. This in simpler terms is simply foregoing immediate gratification to allow for an even larger benefit in the future.

 Impact on the economy

There will be multiple impacts on the economy emanating from reduced issuance of dividends. This article will limit the analysis to overall economic growth.

Should the decision to forego issuance of dividends be as a result of a decision to re-invest, strengthen the balance sheet, build up resilience and so on, then there will be positive impacts on the overall economy in the near future. Long term increase in employment and GDP growth are examples of such decisions.

The converse side has been touched on previously where investors such as pension funds will have less disposable income. Overall, the impact of non-payment of the dividend will be a function of the reasons thereof. Investors must be sure to clearly understand the specific circumstances surrounding their counters before making any decisions.

  • Dziwa is a member of the Icaz secretariat, working as the assistant technical manager. — technical@icaz.org.zw, while Icaz is on Twitter handle: @icazicaz

Recent Posts

Stories you will enjoy

Recommended reading