The dividend life cycle

Identifying a company that will potentially pay a dividend is all about finding the “sweet spot,” in which a company shifts from the ‘growth’ to ‘maturity’ stage in its life cycle. The five stages of a company’s life cycle are as follows:

1. Development - initial equity funds are raised for the start-up and development of the company. These funds are used to purchase property, plant, equipment, raw materials and inventory and to pay staff.
2. Introduction - the company begins to generate cash flows and these flows are used to pay staff, purchase more raw materials and pay taxes, with, it is hoped, proceeds left over.
3. Growth - the remaining earnings are re-invested for expansion as raising new capital externally is costly this early on in a firm’s life. This process repeats itself several times until the firm has either maximised its output or saturated the local market.
4. Maturity - this is the critical step or the ‘sweet spot’ for the firm. It could use its net earnings to launch a new product or expand to a new region, or perhaps preferably from a shareholder’s perspective, it could begin paying a dividend.
5. Survival or decline - Firms ideal for income investors will focus on taking their successful product to new regions, funded by raising new capital, while maintaining a progressive dividend. Those who try instead to enter a new product range are less likely to succeed unless there are synergies with the core product.