Incremental Dividend

An incremental dividend is a series of repeated increases in the dividend a company pays on its common shares. Larger companies with significant cash flow tend to pay incremental dividends as a way to return value to shareholders, and also to flaunt a company’s strong balance sheet to market participants.

Sometimes, corporate management teams communicate their plans to pay incremental dividends to help attract income-seeking investors. Other times, management teams won’t communicate an incremental dividend explicitly, but investors pick up on the pattern of rising dividends over a certain period of time.

An incremental dividend generally is paid only by more mature companies, and firms with low dividend payout ratios, that have the ability to easily increase this ratio over time. Shareholders tend to watch this ratio closely, as it helps to indicate a company’s ability to boost dividends in the future.

Incremental dividends generally are seen positively by the markets. However, there are times when a company’s revenue is either not growing or shrinking, and a company continues to pay incremental dividends. In these situations, shareholders worry that profits won’t be sustainable over time, and neither will the incremental dividend.

Note that many firms pay dividends to shareholders in cash, although some pay in additional shares of stock. The former is generally seen more favorably by investors.

The reason is, stock dividends increase a company’s shares outstanding, and, by doing so, they dilute the value of the shares an investor already holds.

For example, say a company with 2 million shares outstanding declares a cash dividend of $0.50. An investor holding 100 shares, therefore, receives $100. Instead of pocketing that dividend, most investors tend to reinvest it by buying additional shares. Reinvesting dividends typically adds meaningfully to gains an investor might receive just from price appreciation over the long term.

However, say the same investor receives a 5% stock dividend. This means the investor receives 50 additional shares. However, to offer this dividend, the company increases its shares outstanding by 200,000 shares. Because the company now has more shares out and they are backed by the same company assets, the value of the existing shares in circulation decreases.

When a company that pays incremental dividends stops paying them, even once, it’s sometimes very negative for the stock price. The reason is, companies that pay incremental dividends tend to attract a high percentage of income-seeking investors. When it’s unclear to these investors when the stock will pay its next dividend, many tend to move on to other stocks that do pay predictable, incremental dividends.