Penny Stocks & Dividends, An Unlikely Match

Penny stocks are stocks that are trading at substantial discount to their face values. These companies are either going through a bad financial period or have lost substantial portion of their capital or there is some adverse news about the company or the industry/sector they operate in. Penny stocks are the most unlikely ones that will pay any dividends, however there are a few scenarios when such stocks will pay dividends to their shareholders. However, such circumstances are rare and seldom make penny stocks a good investment case. A study of such circumstances is however necessary in order to avoid any pitfalls should anyone consider penny stocks for investments.

First of all one should keep in mind that a dividend is not always a sign of good performance of a company. A company can very well pay dividends when it is not making any profits at all. It may so happen that a company would not be seeing any immediate growth opportunities and may be having surplus cash, more than enough to fund its operations for the financial period. So, it may be inclined to pay dividends to its shareholders so as to keep their interests from waning in the company. Other things remaining as they are, a higher current dividend yield, in the form higher dividends would push the valuations of the company up, which would ideally reflect as an increase in its stock prices. However, when it is the case with penny stocks it could prove disastrous should these valuations be taken at their face value. Below are few special circumstances about dividends that are worth considering while looking at the unlikely scenario of dividend payments from penny stocks.

A recovering company won’t pay dividend – A company which is trying to recover its lost ground, will try to raise funds or reorganize its assets and liabilities so that opportunities may be created for the company to trace its growth back. Such a company will not try to pay dividends. Same is also the case with startup and growth phase companies, who are facing significant opportunities ahead and would like to take advantage of such opportunities. Such companies would try to showcase to their shareholders what future prospects they hold and would try to value themselves as per their long term cash generation potential. Such companies, in the mid-term to long-term, can be excellent investment opportunities that could bring about windfall gains to the investors. Though most of the times shareholders see dividend payments as an enhancement to their wealth, however, they may sometimes reject it in favour of long-term value creation of the company should such possibilities exist. There have been instances where a board dividend proposal has been rejected by the shareholders in favour of working capital preservation or impending corporate events like acquisition or merger which the investors think will bring about significant value to the company. Such companies however offer high risks, high return potential to its shareholders, with the value being generated by the shareholders on their investments coming entirely from capital gains and not dividend income. So should a company in such a stage pay dividend, it could very well be that it is not witnessing any growth or opportunity to recover.

Liquidating Dividend- Liquidating dividends are paid when a company is compulsorily going into liquidation, although a rare event. But a company might pay a good dividend yield to its shareholders if it has surplus assets left over after satisfying all its liabilities at the time of liquidation. Such a situation does not arise if the company is going bankrupt. But in case of business that had been incorporated for a special purpose or for a fixed period of time, it would go into voluntary liquidation, at the fulfilment of the purpose or end of the specified time period when it will first satisfy all outstanding claims against it and if after that there are any remaining assets at its disposal whose combined value is more than the face value of its shares it will pay a liquidating dividend to its shareholders, which is usually the objective of such corporations. This event is, however, in the nature of returning of capital to the shareholders in excess of the amounts they had invested into the company, instead of paying a portion of earnings of the company.

A one-off corporate action or event - There could also be circumstances with a penny stock company when it may be prompted to pay out a dividend from means beyond what it is generating from its business performance. It may so happen that a penny stock company may have entered into a deal where it is selling off a part of its business at a significant profit as part of its reorganisation exercise. In such circumstances, it will become cash-rich in the short run with no immediate redeployment opportunities. In such circumstances, the company would either pay a high cash dividend to its shareholders or prefer to buy back its shares from them, which, in either case, will enhance shareholder value. Such circumstances are usually rare but do happen in the sphere of corporate restructuring and as and when they happen, they make the shareholders of the company cash rich. Such dividends are, however, one-time instances and should be seen as a capital returning instance. A penny stock’s ability to create value out of such corporate action events is also one of the aspect value-seeking investors look for while building up an investment case for a penny stock.

Other Reasons - The stock market volatility could be another reason for stock to trade below its face value in the short term at least. Temporary factors such as an adverse macroeconomic event or an adverse political event or an event specific to the company that has got no relation to the business performance of the company. For example, the sudden death of its CEO or arrest of one of its directors on matters which does not relate to the financial performance of the company, may pull down the share prices of the company to below its face value. When an Investor buys the shares of the company under such circumstances, he is eligible to get dividends that the company would pay as per its financial performance and as per its established policy for dividend payments.