The Positive Effects of Dividends on Stock Prices

By Lawrence Carrel

In the midst of investor irrationality, dividends tend to calm the raging stock market seas by injecting some sanity into the marketplace in a couple of ways.

First, they make managers more accountable to shareholders. Shares of growth companies can be particularly vulnerable to price fluctuations. Obsessed with growth and lacking the accountability to shareholders that dividends provide, managers often spend profits to acquire businesses that don’t fit strategically with their main business.

This disregard can send stock prices soaring when investors believe the acquisitions will increase profits, but disappointments can have the opposite effect, sending share prices to the cellar. Plummeting share prices sometimes give back more than 90 percent of their previous gains. Having to pay dividends encourages managers to be more sensible in their acquisitions and provides them with less cash to squander on poor decisions.

Second, dividend payments provide steadier returns to investors. Even when stock prices are in a freefall, shareholders can usually count on receiving their dividend payments. This dependability not only calms the nerves of potentially anxious shareholders but also gives them more capital to reinvest in the company or in other companies, which can help further in stabilizing the stock market.