Effects of Dividends on Penny Stocks

A "penny stock" is a stock that trades at a comparatively low price. Penny stocks are typically not available on major stock exchanges, such as the New York Stock Exchange, NASDAQ or S&P 500, and typically sell for $5 or less per share. Companies that offer penny stock shares rarely offer dividends to their investors for a wide range of reasons. However, on those rare occasions when these companies do disburse dividends, they can come in one of two forms.

Stock Dividends

Companies that want to reward shareholders but are short on cash may choose to distribute a stock dividend. A stock dividend provides current shareholders with more shares of company stock based on their current ownership levels. For instance, a 10 percent stock dividend gives shareholders an additional stock share for every ten shares they currently hold. This dividend allows shareholders to hold more stock, which they can sell at a profit, while allowing the company to maintain its cash reserves.

Cash Dividends

When a company generates sufficient cash reserves, the directors can choose to reward shareholders with a cash dividend. Cash dividends allow shareholders to generate income from the stock without the need to sell their shares. Cash dividends are paid as a fixed amount per share. For instance, the company can announce a dividend of $0.50 per share, so a shareholder with 1,000 shares will earn a cash dividend of $500. However, cash dividends are rare occurrences for low-cap companies, as they often rely on steady cash flow to stay in business.

Stock Price

In most cases, a stock that issues a dividend sees its price fall. The issue of additional shares through stock dividends dilutes the value of each share. The distribution of cash dividends impacts the company's cash reserves, which also reduces the firm's equity on the other side of the balance sheet. For penny stocks, the effect can be reversed. When investors see a penny stock that regularly distributes dividends, their demand for the stock can rise, which drives up the price and may disqualify it from being a penny stock.

Cancelled Dividends

If scheduling dividends can drive up the demand for a penny stock, cancelling a scheduled dividend can damage its value for many of the same reasons. If the stock drops in value before the scheduled dividend distribution date, the directors may withdraw the dividend and save the company's cash reserves. The cancellation of an announced dividend will usually carry a negative impact with investors, who may choose to sell the stock, which will depress the stock price even further.