In the days of falling stock prices, Board of Directors will often begin to pay dividends to help stabilize the company’s stock. Many investors consider these dividends as a sign of safety and financial conservatism (which they are in many cases). Dividends in and of themselves, however, do not necessarily make the company a better investment. Companies that earn high returns on equity, have little or no debt, and large room to expand in their current industry would best serve their shareholders by paying no dividends. Instead, they should opt to reinvest all of the company’s available resources into growing the value of the underlying business. The shareholders will be rewarded through appreciation in the stock price.
In other words, a company should only pay dividends if it is unable to reinvest its cash at a higher rate than the shareholders (owners) of the business would be able to if the money was in their hands. If company ABC is earning 25% on equity with no debt, management should retain all of the earnings because the average investor probably won't find another company or investment that is yielding that kind of return.
