With the vast majority of stocks, shareholders can start to realize profits when the value of their shares increases during the time they hold them. But a few public companies — most of them large, established, and dependably successful — reward their shareholders further by paying them dividends.
Dividends are a percentage of a company’s retained earnings that corporations reserve as rewards for shareholders’ investment. They’re typically distributed to stockholders on a quarterly or annual basis.
Dividends are good for building and renewing shareholder loyalty, and they’re pretty handy public relations tools for touting a company’s success, too!
Dividends take a few forms, but the two most common are cash and stock dividends. At face value, these two types of payouts are worth the same. But in other ways, there’s a great difference between a cash dividend and a stock dividend.
In this post, the experts at Gorilla Trades will explain that difference in detail.
What Are Cash Dividends?
The payment of cash dividends, as one might expect, comes in the form of money. Companies send shareholders a percentage of cash in proportion to each investor’s stake in the company. The shareholders receive either checks or electronic transfers for the value of the dividend.
For example, say that a company’s board of directors has approved a cash dividend of $0.35 per share to be issued in future weeks. A shareholder that owns 100 shares of this company would get a check or direct deposit of $35. That’s all there is to it.
Cash dividends are more widespread among companies that issue dividends. The value of money is pretty easy to grasp, and for instant gratification, there’s nothing better than sweet, green cash.
One upshot of cash dividends is that they generally have a temporary downward effect on the company’s share price. After a dividend is paid out, you’ll probably see the share value go down by roughly the amount of the dividend.
But the price usually rebounds in short order — companies that pay out dividends are mega-successful, after all, and they aren’t likely to go out of business anytime soon.
What Are Stock Dividends?
Stock dividends are paid out as additional shares in the company that issues them. Instead of receiving cold hard cash, shareholders are rewarded with more shares in the company.
For example, say that another company announces that they’ll reward their shareholders with a 10% stock dividend. An investor with 10 shares would receive another one when the dividend pays out. Someone with 200 shares would get 20 new ones. Even someone with just one share would see a boost in their brokerage account of one-tenth (0.1) of a share.
Stock dividends are often paid out when the company issuing them has limited cash flow or is having a problem with liquidity at the moment. Most brokerages allow their clients to change their cash dividends into stock shares, effectively reinvesting in the company instead of taking the money.
Companies may not say it, but they probably prefer that choice, too.
Stock Dividends vs. Cash Dividends: Some Key Differences
The argument on the preference for a cash dividend vs. stock dividend centers on differences besides the actual form of the payout. Every shareholder has their personal preference.
Here are a few of the main points of comparison in the discussion of cash dividends vs. stock dividends.
Cash Dividends Deplete Company Reserves
Probably the most direct effect of cash dividends is that they draw on the company’s balance sheet. Before they’re paid out, cash reserves are recorded as a liability in the “dividend payable” column.
After they’re paid, the dividend payable is switched around and is no longer a liability. But the effect is a decrease in the company’s retained earnings, which is one reason the share price goes down.
Stock dividends don’t affect a company’s cash reserves one way or the other. On the balance sheet, they affect the shareholders’ equity column.
Cash Dividends Aren’t Company Reinvestments
One knock on cash dividends is what they may imply about the health of a company. Yes, the message behind cash dividends is “Everything’s great…thank you for your business!” But some outsiders see a slightly darker message.
Investors expect the companies they hold shares in to reinvest in themselves — to take part of their earnings and fund growth through expansion, new product research, acquiring other companies, and so forth. The money the company gives out as cash dividends doesn’t go toward those efforts.
If the cash dividend is exceptionally generous, investors may wonder why the company is sending them money that should be used to grow the business (and, ergo, increase the company’s overall market value). A cash dividend may raise concerns that the company’s forward momentum has halted.
Stock dividends don’t send quite the same message. The company’s cash reserves stay intact if they issue stock dividends, and its balance is available for reinvestment in growth strategies, tempering many investors’ qualms.
However, since the company’s issuing more shares of stock, the value of each share gets diluted a little.
Cash Dividends Are Taxable
Cash dividends represent straight income. It’s money that shareholders earn in relation to the shares they hold that goes straight to the bank. Therefore, being income, it’s subject to tax regulations.
In stock dividends, no cash is being exchanged. All the company does is release new stock shares and distribute them to current shareholders. This means that stock dividends are not taxable. Stockholders are only responsible for the tax if they sell their shares, generating a capital gains liability.
This can have implications on shareholders’ year-end tax returns, although the effect may be minimal in the big picture.
Stock Dividends Affect a Company’s Ownership Structure
Just a few seconds ago, we discussed how cash dividends reduce a company’s retained earnings, which stock dividends do not. But stock dividends still have an effect on the company in terms of ownership stakes.
When a company releases more stock shares, it’s offering an ever-so-slight increase of ownership to the public. The percentage difference may not be that great, but there’s a chance the “free float” of shares may affect stock prices and raise some modest concerns.
Theoretically, it could redistribute ownership to certain individuals or investor blocs that could in turn try to change or make an impact on the current company. Some companies don’t like that idea.
Stock Dividends Eventually Won’t Have the Same Value as Cash Dividends
When you get a cash dividend, you get a set amount of money. With a stock dividend, you get a stock equivalent to a given amount of money. But that price will change with the share price.
For example, if you earned $300 in cash dividends from a company you invested in, that’s — well, $300. Three hundred clear, unambiguous bucks.
But if you earned stock dividends that equaled $300 in current value, that price isn’t going to be the same tomorrow. Hopefully, after a modest dip in share price, it’s going to appreciate as the company grows. If you hang on to that stock, it’s going to be worth more than $300 in the future.
This is what happened to the “Microsoft millionaires” who saw a lot of stock splits not long after the company went public in 1986.
Of course, it’s also possible the stock will decrease in value. But again, given that companies that issue dividends are generally in a healthy state, a drastic drop-off won’t likely be the case.
Stock Dividend vs. Cash Dividend: What Do Investors Prefer?
To be honest, for most retail investors with smaller brokerage accounts, neither cash nor stock dividends really “move the needle” when it comes to their financial standing. The cash dividend tax liability isn’t significant, and the stock dividends are usually fractional.
Dividends don’t come into meaningful play unless the shareholder owns multiple hundreds or thousands of stock shares.
But you can infer short-term investors may lean toward companies with cash dividends since there’s an immediate payout, however modest. More active investors that get access to dividend-paying stocks probably prefer to look for the straight cash reward — but they have to get a lot of shares to make that reward relevant.
Investors with a longer view in mind, though, may prefer to take stock dividends. There’s every potential the stocks will go up in value.
There’s also the “pride of ownership” angle with stock dividends — a psychological sense of connection and a tangible financial bond between shareholder and company. It’s not something you can quantify, but it is something that long-term shareholders seem to value.
Whichever “flavor” you prefer, cash and stock dividends are low-effort ways to capitalize on a big company’s continued success.
Gorilla Trades: Dividends of Another Kind
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