What is an additional dividend?
A supplemental dividend is a series of repeated increases in the dividend a corporation pays on its common stock. Large companies with strong cash flow tend to pay out additional dividends in order to restore shareholder value. The steady increase in the dividend is also a signal to investors that the company is doing well.
Sometimes corporate management teams communicate their intention to pay additional dividends to help attract income-seeking investors. Other times, management teams don’t explicitly communicate an additional dividend, but investors pick up on the pattern of rising dividends over a period of time.
Key points to remember
- An additional dividend is when the dividend payment is increased over time.
- Mature companies with low dividend payout ratios are more likely to offer additional dividends.
- A steady increase in dividends is a sign that a company is doing well.
- A company that steadily raises its dividend and then stops raising it, or lowers it, can scare off investors, especially income-seeking investors.
How the additional dividend works
An additional dividend is generally paid only by mature companies and companies with low dividend payout ratios, which have the necessary cash and earnings to easily increase the amount of the dividend over time. Shareholders tend to watch this ratio closely, as it helps indicate a company’s ability to increase dividends in the future.
A company that already pays out high dividends, meaning current dividends make up the bulk of its revenue profits— have little ability to increase dividend payouts unless earnings/earnings improve. On the other hand, a company that pays out a small portion of its profits as dividends has more room to increase its dividend without negatively affecting cash flow.
Additional dividends are generally perceived positively by the markets. However, there are times when a company’s profits do not increase or decrease and a company continues to pay out additional dividends. In these situations, shareholders may fear that the profits will not be sustainable over time, and neither will the additional dividend. When a company pays dividends that it cannot afford, investors may view this as a negative because it hurts the long-term viability of the company.
Types of dividends
Many companies pay dividends to shareholders in cash, although some pay out additional stock. The former is generally viewed more favorably by investors.
For example, say a company with two million shares outstanding declares a cash dividend of $0.50 per share. An investor holding 100 shares receives $50 ($0.50 x 100 shares). Instead of pocketing this dividend, some investors reinvest it by buying additional shares. Reinvest dividends generally adds significantly to the gains an investor might receive from simple long-term price appreciation.
However, let’s say the same investor receives a stock dividend of 5%. This means that the investor receives 5 additional shares (5% of 100 shares). However, to deliver this dividend, the company increases its outstanding shares by 100,000 shares (2,000,000 x 1.05). Because the company now has more shares outstanding that are backed by the same assets of the company, the value of the existing shares outstanding decreases.
End of an additional dividend
When a company that pays extra dividends stops paying them, even once, it’s sometimes negative for the stock price. The reason for this is that companies that pay extra dividends tend to attract a high percentage of looking for income investors.
When a company that has been steadily increasing its dividend suddenly stops, it sends a signal to investors that the company is no longer growing or can no longer afford to continue increasing the dividend. Investors can jump ship, taking this as a negative, and reinvest those funds in another stock that continues to steadily increase its dividend.
Actual example of an incremental dividend
Target Corporation (TGT) is an example of a company with a steady growth in its dividend. Since 1972, Target has increased the amount of the dividend every year.
The dividend started at $0.0021 per trimester in the last quarter of 1967 and throughout 1968.
1969, 1970 and 1971 saw an increase to $0.0026 per quarter.
Starting in 1972, the payment of dividends increased each year until 2019. In 2020, the company paid $2.68 in dividends for the year, an average of $0.67 per quarter.