# what's a dividend?



## the-royal-mail (Dec 11, 2009)

I've learned a few things along the journey of life, but there are some things I just don't get. I'm great at saving, very bad at investing. Mostly because I just don't get it. And yes, I've tried to read up on this but right away the terminology causes my eyes to gloss over.

Can someone here please not pass judgement, but explain to me what a dividend is, in very simple terms? Please do not post links (which are normally plastered with distracting ads) or recommend that I buy books. That stuff puts me to sleep. So I'm hoping someone here can provide a basic explanation so I can interact and ask questions and ultimately know what people are talking about.


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## Four Pillars (Apr 5, 2009)

the-royal-mail said:


> I've learned a few things along the journey of life, but there are some things I just don't get. I'm great at saving, very bad at investing. Mostly because I just don't get it. And yes, I've tried to read up on this but right away the terminology causes my eyes to gloss over.
> 
> Can someone here please not pass judgement, but explain to me what a dividend is, in very simple terms? Please do not post links (which are normally plastered with distracting ads) or recommend that I buy books. That stuff puts me to sleep. So I'm hoping someone here can provide a basic explanation so I can interact and ask questions and ultimately know what people are talking about.


http://www.abcsofinvesting.net/what-are-stock-dividends/


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## Dr_V (Oct 27, 2009)

Simplified version:


1. Company makes money.

2. Rather than keep all of its money for itself, Company decides to give a little bit of what it earned back to its owners/shareholders.

3. It might do this "regularly" (like, every quarter); or it might be a one-time thing. (When you own a dividend-paying stock, the cash money will appear in your trading account.)


General points to consider:

A. Some companies don't pay dividends. They keep the money, and "reinvest" it for themselves. The argument being that, by keeping the money within the company (and not giving it to the shareholders), it will be better for shareholders in the long run.

B. The dividends that you make are taxed really favourably in Canada.

C. Dividends "smooth out" the bumps. What I mean is, your stock will go up and down regularly, and that ~2% dividend that it pays acts like a bit of a "buffer" against minor drops in price at any time. It turns out that, in the grand scheme of things, dividends are actually pretty important in achieving good long-term returns. So it's a good idea to look for companies that pay some dividends.

K.


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## the-royal-mail (Dec 11, 2009)

Bless you.

>1. Company makes money.

What if it does not?

>2. Rather than keep all of its money for itself, Company decides to give a little bit of what it earned back to its owners/shareholders.

Why would it not keep all the money for itself? Aren't they in biz to make money?

>3. It might do this "regularly" (like, every quarter); or it might be a one-time thing. (When you own a dividend-paying stock, the cash money will appear in your trading account.)

I see - sounds interesting. So not all stocks pay dividends? 

How does the average person access these? I imagine the best thing would be to shelter them in an RRSP or TFSA?


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## Dr_V (Oct 27, 2009)

the-royal-mail said:


> What if it does not?


Sometimes, companies pay out too much in dividends -- they pay out more than they have made. This can happen, for example, if a company has been paying a dividend every quarter for the last 20 years, but let's say they've had a bad fiscal year, and they haven't made any money. 

In that case, the company may still keep paying out the dividend because they don't want to "spook" investors by cutting it. Some may consider the dividend to be "at risk of being cut" (either reduced or eliminated). This can have a detrimental effect on the stock price.... 

One way of looking at it is: there are all sorts of people who buy the stock _purely_ for the dividend. Consolidated Edison (symbol: ED) is an electricity company that pays out a ~5% dividend yield, which sure beats GICs; it's a stable company, but it isn't really growing too fast, because it's tied (in effect) to the number of people living in the state of New York. If ConEd cut their dividend ... people would no longer have any reason to hold the stock. There would likely be a massive sell-off, and the share price would plummet.




> Why would it not keep all the money for itself? Aren't they in biz to make money?


Well, that's Buffett's philosophy. The company that he runs (Berkshire Hathaway) doesn't pay dividends for basically this reason.

My view -- and the views of many others -- is that dividends are a way of giving shareholders back a little bit of money as compensation for the risk that they take in holding the stock.

Also, many companies distribute dividends because they believe that they're already as big as possible, and that there isn't much (big) upward movement left in their stock price. So again, to "compensate" shareholders (for likely not having big-time stock movements), they give out juicy dividend yields.



> I see - sounds interesting. So not all stocks pay dividends?


Correct. It used to be that almost all stocks paid dividends. Nowadays, there are plenty of companies which don't. Usually, dividends are a sign that a company is pretty healthy. (They have some extra cash to give back to the owners.)



> How does the average person access these? I imagine the best thing would be to shelter them in an RRSP or TFSA?


If you have a trading account, you just buy a stock that has a good track record of offering dividends. Let's say you buy 100 shares of company X, and that they pay $1 per share in dividends every quarter. What you'll find is that, if you hold the company for a few months, $100 will be deposited into your account.

There are also dividend-paying mutual funds -- the mutual funds hold a basket of stocks, some of which pay dividends, and they pass these dividends on to you. That's another way to get access to dividend income.

K.


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## the-royal-mail (Dec 11, 2009)

Fascinating. I have read every word. Thank you so much.

I have mutual funds sheltered in my RRSP. How would I know if they pay dividends? I noticed my account value has been going up for the past few months, finally.

Sooo isn't this dividend thing what all investors do? Sounds to me like dividend-paying stocks are a great thing. Why would a person NOT invest in such stocks?

And is there a clear way of knowing whether or not a given stock pays dividends? Is that info clearly disclosed upfront when you go to choose them?

(I must admit I've never invested in terms of stocks. Though I note CN Rail has done very well since privatization in 1995, FWIW.)

I have my mutual funds at the bank, during good economic times (I'm rated as aggressive) the returns on these are excellent. Would I have access to one of these trading accounts you mention? Can anyone sign up for one of those? I guess I have to give SIN number and all that stuff so they can tell CRA about me?


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## andrewf (Mar 1, 2010)

the-royal-mail said:


> Fascinating. I have read every word. Thank you so much.
> 
> I have mutual funds sheltered in my RRSP. How would I know if they pay dividends? I noticed my account value has been going up for the past few months, finally.
> 
> ...


The purpose of a corporation is to create value/return on investment for shareholders. Corporations aren't supposed to make money for the corporation's sake (and when this does happen, this is considered a problem--management not acting in the shareholders' interest). There are three ways for a company to produce value for shareholders:

- use today's profits to invest more, grow and increase future profits
- use today's profits to pay dividends
- use today's profits to buy back shares, decreasing the number of shares and increasing the value of the shares that remain (since they represent a larger proportion of ownership in the company).

The reason why a company might not pay dividends is that it is often more tax efficient for the shareholder to go with the first or third option since these will result in capital gains, but that capital gain will only be taxable upon sale, which could be twenty years from now. It is a way of deferring taxation.

The reason a company pays out dividends or buys back shares rather than further investing in its operations may be because there are few investment opportunities that offer good rates of return. You could think of the company's shares as an investment. If the return on those shares is higher than the company's investment opportunities, it might make sense to 'invest' in those shares by buying them back for the remaining shareholders.

If you don't want a margin account (one with credit), it should be pretty easy for you to get a brokerage account. You just need to deposit the minimum to start the account, which is usually $2000 - $5000.


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## MoneyGal (Apr 24, 2009)

the-royal-mail said:


> Why would a person NOT invest in such stocks?


Lots of reasons. The risk profile of dividend-paying stocks is quite different from non-dividend-paying stocks. Prudent investors will be aware of the tradeoffs they are making when they purchase dividend-paying stocks vs. non-dividend-paying stocks. 

Also, if you don't need income from your portfolio, you don't need dividends. Dividends do not equal growth - they are income (unless you receive stock dividends, which are less common; but that's still not income - it's more like a stock split).


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## Kirkland (Sep 15, 2009)

Great thread, thanks for the thoughtful responses.


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## bean438 (Jul 18, 2009)

MoneyGal said:


> Lots of reasons. The risk profile of dividend-paying stocks is quite different from non-dividend-paying stocks. Prudent investors will be aware of the tradeoffs they are making when they purchase dividend-paying stocks vs. non-dividend-paying stocks.
> 
> Also, if you don't need income from your portfolio, you don't need dividends. Dividends do not equal growth - they are income (unless you receive stock dividends, which are less common; but that's still not income - it's more like a stock split).


I don't need income but I will still accept my growing dividends. 

With dividends you don't have to sell capital to eat. 
Dividends provide a floor to your stock price. 
As dividends grow so will the stock price. 
Dividend stocks tend to do well in bad times because people perceive them to be safe. 

Dividends are not just about income, and have a place.


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## MoneyGal (Apr 24, 2009)

All valid points Bean, but I respectfully disagree. 

I don't need to sell anything to eat. I'm living off my salary, not investments. 

Your next three points are assertions that I'm not personally betting my future on. 

Don't get me wrong. I have lots of dividend-paying stocks in my portfolio - but mostly because I mostly use index funds. 

I also do some active trading, but don't have any dividend-payers in that tranche, nor do I ever anticipate putting dividend-paying stocks in that portion of my portfolio. 

I disagree with the floor theory; while your second assertion may be true it is too conditional for me; and I've never been all that interested in following strategies based on what other people may think or do.


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## Sampson (Apr 3, 2009)

bean438 said:


> I don't need income but I will still accept my growing dividends.
> 
> With dividends you don't have to sell capital to eat.
> Dividends provide a floor to your stock price.
> ...


I also disagree with the basic thesis of what you write here Bean.

While I agree with the benefits you outline, I don't believe paying stable and growing dividends are the cause, just the side effect of strong company philosophy. The companies and their stocks do well because of other reasons, most notably cost control and ability to generate real organic growth.

But these same companies don't have the same potential for capital appreciation - many small cap stocks I follow have the earnings growth and income to pay out sizeable dividends, but I am happy they don't. I find different importance in companies that don't pay dividends.


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## MoneyGal (Apr 24, 2009)

There is also a strain of thought which suggests that increasing dividends means a company is "out of good ideas."


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## Dr_V (Oct 27, 2009)

the-royal-mail said:


> Fascinating. I have read every word. Thank you so much.


Any time.



> I have mutual funds sheltered in my RRSP. How would I know if they pay dividends?


I don't have a lot of familiarity with mutual funds any more, but I'm guessing that the account has both a cash component and a component allocated to mutual funds. You may be able to see that your cash is going up. Thinking back to when I used to hold some funds (10+ years ago), I seem to recall that my mutual funds paid a regular "distribution", which is kind of like a dividend -- it's basically where they bundle together all of the dividends and other income that they made, and then distribute them to the mutual fund holders.



> Sooo isn't this dividend thing what all investors do? Sounds to me like dividend-paying stocks are a great thing. Why would a person NOT invest in such stocks?


I like dividends, and generally look for stocks that pay them. I don't need a lot -- a little is fine. Just enough to "smooth the bumps", as I say. (Aside: Dividends are a requirement of Ben Graham's Defensive Investor stock criteria, which is what I use for establishing whether or not I want to buy a particular stock, and so seeing a company that provides a small but reliable dividend payment is a sign of strength for me.)

Anyway, as for why you wouldn't want to own such stocks -- there are a lot of reasons which I probably can't all enumerate ... things like: 


the company is paying more than what it earns (so the dividend likely to be cut in the near future)
very high-paying dividend companies may not accrue much in terms of their stock price. So, while a 6% dividend yield is nice, people who can take more risk would probably be happier assuming a bit more risk by buying a company that pays a 1% dividend yield but has a higher chance of the stock doubling in value.



> And is there a clear way of knowing whether or not a given stock pays dividends? Is that info clearly disclosed upfront when you go to choose them?


Yes. The historical dividends are listed on things like annual reports, and are also available for free online. e.g., Walmart (look for the box saying "trailing dividend yield"), and compare this versus AT&T.



> Would I have access to one of these trading accounts you mention? Can anyone sign up for one of those? I guess I have to give SIN number and all that stuff so they can tell CRA about me?


Pretty much anyone can sign up for a regular discount brokerage trading account at, say, TD Waterhouse. (That's who I use.) 

Caveat: Going from buying funds to investing in stocks is a big step, and requires devotion to a lot of reading & learning, in my opinion. For many people, "couch potato portfolios" using index funds or ETFs work very well. This is another topic unto itself.


K.


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## Toronto.gal (Jan 8, 2010)

the-royal-mail said:


> And yes, I've tried to read up on this but right away the terminology causes my eyes to gloss over.


That's how most of us felt when we first started out, so don't feel bad.

Since you're new at this, if you haven't already, you might want to read 'The Lazy Investor' by Derek Foster, which is a straight forward read. Also, 'The Intelligent Investor' by Benjamin Graham & 'The Single Best Investment' by Lowell Miller. 

I know you did not want any book recommendation, but they are at the library and the 1st one answered many of my questions, easiest book I ever read!.

Happy learning & good luck investing.


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## the-royal-mail (Dec 11, 2009)

You are all amazing. Thank you DRV and toronto and everyone else.

gal, thanks for your understanding. I know what you mean and I'll check out those books at some point. I just wanted the ability to interact with someone and ask questions and have them answered one point at a time, like DRV has done, in this forum. I find a lot of the websites linked to from this forum are absolutely covered in advertising and sidebar distractions. These are extremely irritating to me, especially when I'm trying to learn and read and have to keep dodging the advertising. Most times I just give up in frustration. I'm also trying to eliminate bias by asking questions in a plain text forum such as this. I think I'm getting the hang of this, fortunately I can re-read some of the posts and comments by Dr V.

Again, you guys and this forum are amazing. I really appreciate it.


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## Four Pillars (Apr 5, 2009)

Royal, if you want free content then you have to put up with the ads. 

FYI - there are ad-blockers you can use which will cut out a lot of the clutter.


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## Dr_V (Oct 27, 2009)

Four Pillars said:


> Royal, if you want free content then you have to put up with the ads.


This is probably off-topic, but I've been using FireFox + AdBlockPlus, and haven't seen ads online in a long time.
(For reference, I believe that Chrome also supports these add-ons.)


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## Berubeland (Sep 6, 2009)

Just to let you know.... more is not necessarily better with dividend paying stocks. 

I had the bright idea of more is better but dividend stocks are more like vitamins than chocolate cake. 

I picked the top paying dividend stocks all over 20% payout. The dividend was the only criteria I used. 

That portfolio is down 10% including the dividends payed out. 

If a stock you own has a dividend and the dividend is cut you can look forward to it dropping through the floor. So that sucks.


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## the-royal-mail (Dec 11, 2009)

Thanks Berube - good point.

Would you say that dividend cuts are a fairly common occurence?

P.S. Yeah I have Firefox with all the ad and spyware and trackware blocked on one computer but the 2nd computer I use can't be modified thusly. So I just don't visit websites that are plastered with ads.


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## Berubeland (Sep 6, 2009)

First I want to say that this bright idea of mine was exercised in a virtual portfolio using globeinvestor. 

Thank god I did not contribute real money to my errant plan. 

Dividend cuts are common when a company is paying out more than it takes in. So income is $100 and expenses plus dividends payed out equals $120 there is a shortfall of $20 that has to come from somewhere. 

Because dividend cuts tend to drop a stock through the floor it seems that companies avoid it as much as possible. But eventually the math catches up to them and they must stop or reduce their dividend. If fact it's actually a good thing because then the company will not go bankrupt. 

Hmm there might be a strategy there. Has anyone ever tried to buy companies in the first few days after their dividend cuts and waited until they recovered? or not?


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## humble_pie (Jun 7, 2009)

but those weren't true dividends, properly called "eligible" dividends, meaning dividends paid out by corporations that are eligible for federal & provincial dividend tax credits.

the payouts from every single entity in berubeland's virtual portfolio were distributions from unit trusts.

distributions include a mixture of return-of-capital, true dividends, interest, sometimes foreign income. Each of these distribution components has a different tax consequence.

it's unfortunate that ordinary language has evolved to the point of calling distributions of whatever nature "dividends," because this practice is profounding confusing. Elsewhere in this forum there's a thread in which people are discussing how to identify eligible dividends. Several posters have made the difference clear, over and over again.

to return to berube's unit trusts, these were taken from a simple screener as the highest paying, ie the highest yield. Of course many of these trusts were failing. It's common with the weaker unit trusts to see them selling new debt as debentures in order to raise the money to continue paying the inflated distributions. This is a mug's game.

it is not true that blue chip eligible corporate dividends are fly-by-night payments that come and go. A slight majority of companies, and of course particularly the blue chips, take their dividend histories very seriously, refusing to raise dividends - as the big banks refused last year & so far this year, for example - when they see risks to sustainibility.

a year ago, even 6 months ago, there were strong real dividend payors with attractive yields. Companies such as bce, cnr, cpg as well as the banks. It's interesting to see how share prices of these corporations have stormed powerfully upwards, and concomitantly the dividend yields have fallen. My own sense happens to be that share prices of these strong candidates will continue to rise until such point as their exceptionally high eligible dividend yields become more in line with the overall market. However, we've covered a lot of the upward ground already.

with all due respect, i believe that anyone pointing to a skewed screen of weak unit trust distributions as evidence that dividends "suck" is misleading other investors.


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## Berubeland (Sep 6, 2009)

@ humble pie,

I did not say the dividends suck. I merely pointed out the danger of assuming the more is better where dividends are concerned. That is why I did the trial in the first place. I wanted more information and so I created a virtual portfolio. 

You are also correct in assuming that most of my virtual portfolio was trust units. 

For a novice investor buying something with a high yield might seem like a good idea. From my experiment I can tell you that it is not a great idea so far. Time will tell more. 2 are doing ok. 

Also to be noted is that for me who does not have a lot of capital I simply cannot afford to buy in on blue chip dividend funds. I cannot be the only one in this position. 


Amalgamated Income LP	AI.UN-T	
Boralex Power Income Fund	BPT.UN-T	
CanWel Building Materials	CWX-T	
Consumers Waterheater Fund	CWI.UN-T	
Global Credit Pref Corp GPA.PR.A-T	
Global DIGIT II GII.UN-T	
Multi-Manager Ltd. Part. I	MMN.UN-T	
Pizza Pizza PZA.UN-T 
SIR Royalty Income Fund	SRV.UN-T	
Supremex Income Fund SXP.UN-T	


I created this portfolio October 2009 I bought 100$ worth of every stock $1000 total, current market value is 902.16 plus income received is 59.01 so losses are 38.83 total. So not really horrifying. If I check after a good week it may be in positive territory. 

If I compare to my Wallstreetsurvivor portfolio created around the same time, today it's up 119%


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## Dr_V (Oct 27, 2009)

Berubeland said:


> I did not say the dividends suck. I merely pointed out the danger of assuming the more is better where dividends are concerned. That is why I did the trial in the first place. I wanted more information and so I created a virtual portfolio.


You've constructed a portfolio based on a single variable (large dividend yield), and are cautioning that this single variable alone does not work well for selecting stocks. This shouldn't be too surprising...

Good stock screens usually comprise multiple variables, and even then, the screens themselves are not sufficient for constructing a real-world portfolio. Plenty of "due diligence" (reading annual reports & cash flow statements, and looking at the company's historical track record) is required before settling on each individual stock.

As for constructing hypothetical portfolios -- I might suggest NormR's Graham approach as a good starting point, as I believe that it offers a more reliable strategy for selecting dividend-paying stocks because it attempts to encapsulate the company's financial health into the model. Alternatively, NormR also has discussion on high-yield approaches to stock selection.


K.


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## Cal (Jun 17, 2009)

Berubeland - the book 'little book of big dividends' talks about how to look for stocks and value the dividend yield, in regards to whether they are too high, or low, based on other stocks in the same sector. It is an easy read. Glad that you did the virtual portfolio first.

Humble - 'My own sense happens to be that share prices of these strong candidates will continue to rise until such point as their exceptionally high eligible dividend yields become more in line with the overall market.' - Agreed.


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## FrugalTrader (Oct 13, 2008)

From my experience, if you're going to invest in dividends, stick with the companies that have a long track record of paying and increasing their dividend over time. Wait for those companies to dip in stock price, then buy and hold. Stocks like the big banks, enb, fts, trp, pwf, cnr etc.


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## the-royal-mail (Dec 11, 2009)

Berubeland said:


> @ humble pie,
> 
> I did not say the dividends suck. I merely pointed out the danger of assuming the more is better where dividends are concerned. That is why I did the trial in the first place. I wanted more information and so I created a virtual portfolio.
> 
> ...



Very interesting experiment! I never knew you could create virtual portfolios like that.


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## bean438 (Jul 18, 2009)

FrugalTrader said:


> From my experience, if you're going to invest in dividends, stick with the companies that have a long track record of paying and increasing their dividend over time. Wait for those companies to dip in stock price, then buy and hold. Stocks like the big banks, enb, fts, trp, pwf, cnr etc.


This is exactly what i do. I am comfortable with it, and it really works.
To suggest dividends are only for income does not do them justice, although the income is nice.

When "it" happened and the world was ending, and the global economy was going to collapse, and the skies would open up, and the rivers turn to blood, my dividend income actually went up, even with 2 dividend cuts. Actually my income has always gone up.

There are many ways to invest. If there was only one "system", or style then we would all just invest and grow wealthy.

Pick something you are comfortable with, and stick with it. 

Dividends are popular right now, and stocks are priced accordingly. In a few years dividends will not be "cool" any more, and people will dump them because they are boring, they suck, and "my friends cousins hair dressers dog sitter is getting rich with (enter hot stock of the day) so i will too.

Jump off the train and hop on the next loser train.


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## Dr_V (Oct 27, 2009)

bean438 said:


> When "it" happened and the world was ending, and the global economy was going to collapse, and the skies would open up, and the rivers turn to blood, my dividend income actually went up,


I chuckled.


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## OptsyEagle (Nov 29, 2009)

Berubeland said:


> Because dividend cuts tend to drop a stock through the floor it seems that companies avoid it as much as possible. But eventually the math catches up to them and they must stop or reduce their dividend. If fact it's actually a good thing because then the company will not go bankrupt.
> 
> Hmm there might be a strategy there. Has anyone ever tried to buy companies in the first few days after their dividend cuts and waited until they recovered? or not?


Berubeland, it depends on why the dividend needed to be cut and whether it's effects are over or not. The problem with buying companies that cut dividends is most times it's due to real operational problems. In these cases, a dividend cut is a pretty good signal (if you didn't get one earlier) to get out. In a few cases, however, it signals other things. A good place to rummage through here is in the income trust space. Many companies here are currently cutting dividends simply to make an allowance for new taxes they have to pay. This has nothing to do with their businesses, however, investors who were living on those dividends have sold them without real review of the situation. 

Many other income trusts took on too much debt, doing what many would say, is run their ponzi scheme where they paid out all their profits and simply borrowed the money to fund their growth. The debt crisis caught up with them and with the new tax measures, they have cut their dividends to pay down debt (probably forced to by the bank). The interesting thing here, is many of them, if they simply kept the millions of dollars they were paying out and re-direct it to their debt, their balance sheets will look prestine in 2 or 3 years (probably why the bank insisted upon it) and since they are in stable businesses, the dividends will most likely resume (albiet at a smaller level than before) at that time. Here the prospects for success are better. Also would be companies like US banks, Manulife and few others where a dividend cut will position them in a better more dominant position then if they kept paying it or resumed it.


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## 72camaross (Apr 26, 2010)

This is a good read. Dr_V you have some very well explained posts! Looks like there is some more reading/learning to do!


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## the-royal-mail (Dec 11, 2009)

This thread has had a LOT of views. Any value to locking it at the top for the benefit of others?


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