Market psychology and dividends have a lot to do with each other. These two are very much connected concepts. Read this article to learn about their relationship.

Market Psychology

The stock market is the collective outcome of the strategies of millions of investors. Even though stock prices are based on the value of the underlying company, fluctuations in the stock market are hugely influenced by human psychology.

If, for instance, an investor thinks the future is bright for a given company, this investor usually wants to invest as soon as possible to reap the maximum profit. If enough investors feel the same way, the increase in investment drives the stock prices up, thereby fulfilling the investors’ prediction. Conversely, shareholders who believe a stock is about to take a dive usually sell in a hurry to avoid losses.

Basically, when the overall opinion of investors is positive, stock prices go up. When the general consensus is less than optimistic, prices tend to decline. In spite of the apparently complex nature of the market, most activity truly boils down to the cumulative effect of investors trying to predict what the others are thinking.

Dividends and How They Work

For investors, dividends are a popular source of investment income. For the issuing company, they are a way to distribute profits to shareholders, being a way to pay them off for their support and to encourage additional investment.

Dividends also serve as an announcement of the company’s success. Since companies can only issue dividends from their retained earnings, only companies that are actually profitable issue dividends with any consistency, although some companies issue dividends to create an illusion of profitability.

Dividends are given out in cash, though they can also be issued in the form of additional shares of stocks. Whichever the case is, the amount of cash that investors receive is dependent on their current ownership stakes.

When a dividend has been paid, the total amount is deducted from the company’s retained earnings, which refers to the total amount of profit that a company has accumulated over time that has not been put to other uses.

Dividend Psychology Effects

Stocks that pay consistent dividends are popular among investors. Even though dividends are not guaranteed on common stocks, many companies pride themselves of generously rewarding their shareholders with consistent and sometimes increasing dividends each year.

Companies that do this are considered as financially stable. And when they are financially stable, investors think of them as good investments, especially to buy-and-hold investors who are mostly likely to benefit from dividend payments.

On the flip side, when a company that historically pays dividend issues a lower than normal dividend, or no dividend at all, this is treated as a hint that the company is currently on a rocky road. Of course, such situations can also mean that the company’s profits are being used for other purposes like funding an expansion.

However, the market’s belief in the negative situation tend to be more powerful that the truth. Many companies try their best to pay consistent dividends to avoid spurring fear among investors, who may see a skipped dividend as an unpleasant bad news.

Harriet Ballard