What Are The Differences Between Cash Dividends And Stock Dividends?
A dividend is the distributed profit by a corporation to its shareholders. This is how corporations give back to their investors as they contributed capital to its successful performance, and maintain a good rapport between them. Periodically, a corporation pays dividends with an amount that depends on each shareholder’s investment to the company. The decision in allocating a portion of retained earnings is developed by the Board of Trustees. The management shall agree to a decision if there must be an appropriated budget for the dividend payment or what kind of dividends shall be distributed.
Most corporations usually issue two types of dividends: cash dividends and stock dividends. Therefore, investors must familiarize themselves with these types of dividends because they will surely encounter both in the future. In this article, we are going to specify the distinctions on every aspect of these dividends in order to bring awareness of why corporations pay a particular dividend. Consequently, this will eventually help you utilize the knowledge to your advantage towards a successful investment experience.
What are Cash Dividends and Stock Dividends?
A cash dividend is a regular payment in the form of money taken from the retained earnings of the company. Normally, cash dividends are distributed quarterly after prioritizing the payment for the company’s outstanding debts.
A stock dividend, which is also called as scrip dividend, is an allocation of a company’s additional shares originating from unissued shares. This type of dividend is being distributed instead of paying cash dividends to the shareholders if the company’s liquidity is low. Companies distribute stock dividends in order to repay their shareholders without spending cash. Therefore, companies are able to retain their assets and appropriate them for expansion purposes.
Stock Market Calculations
The amount of cash dividend to be given on a shareholder is different from another shareholder depending on their number of shares since it is issued on a per-share basis. For example, if the Board of Directors declared $20 per share, an investor that owns 10,000 shares will receive $200,000 worth of cash dividend. Even if the cash dividend is stated at a specific percentage, the result will always be the same. Let’s say 10% is issued as a dividend on a $200 par value per share. The investor on the preceding example will still get the same amount of $200,000.
The amount of cash dividend that investors will periodically acquire depends on how many times the company will issue annually. Using the previous example, the company pays cash dividends quarterly. Therefore, shareholders will receive $5 per share every 3 months.
With the allocation of stock dividends, the retained earnings are being capitalized while shareholder’s equity stays unchanged before and after its declaration and distribution. The allotment of the stock dividend only expands the number of shares but does not affect the benefits nor the ownership of its shareholders. For instance, a corporation that has 300,000 shares declares a 20% stock dividend. As a result, a shareholder that possesses 3,000 shares from that corporation will gain 600 more shares. The shareholder that owns 10% from the shareholder’s equity will maintain its portion from it after earning a 20% stock dividend and the market price of the stock remains the same.
A small stock dividend considers the distribution of additional shares of less than 25% chargeable to retained earnings at the market value. While the additional share of 25% is considered as a large stock dividend that must be charged at the par value.
Advantages of Cash and Stock Dividend Acquisitions
Obtaining cash dividends will benefit investors whose goal is to earn cash regularly. Cash dividend-paying companies are obliged to pay cash to their shareholders regardless of the companies’ financial status. Therefore, investors must carefully pick the cash-dividend paying companies to invest in for them to ensure a permanent source of passive income.
Through cash dividend, investors are also given the freedom not only to spend it for personal use, but they can also buy more shares from the same company and buy shares to another company concurrently. Shareholders who are willing to reinvest their cash dividend must undergo on a dividend reinvestment plan. Buying more shares is a wise way to earn more money in the future if you believe that the company and economy have the potential to grow.
The advantage of gaining stock dividends instead of the cash dividend is that investors will not incur tax from its acquisition. However, receiving a stock dividend with a cash dividend option included is subject to tax. Investors can sell their stock dividends in exchange for cash. Due to the sale of the stock dividend, it will not be exempted from tax anymore.
Disadvantages of Cash and Stock Dividend Acquisitions
The liabilities of a company increase because it is paying out cash dividends to its shareholders. The companies that distribute cash dividends may either have enough cash flow to support its growth or just feel obliged to give back to its shareholders in order to gain their trust. If a company still pays out cash dividends while still having losses and outstanding debt, that’s already a sign of its financial instability. Instead of distributing cash dividends, companies could have allocated their cash for expansion purposes which may result in market price appreciation. Aside from that, the cash dividends earned by shareholders are subject to tax based on the amount received.
Stock dividends don’t have any value for investors who are expecting cash from the company they capitalized on. For that reason, they are pressured to sell it even for an amount lower than the dividend’s market price. In addition to that, shareholders will incur costs and taxes from selling their stock dividends.
Reasons Companies Issue Dividends
Cash dividends are issued by companies because they already obtained ample earnings. It is predicted that giving back to their shareholders will not affect long-term financial strength. These cash-dividend paying companies pay out cash because they might have a good financial position but has a limited capability to venture on expansion to spend their cash up. Companies tend to issue stock dividends to their shareholders when it is not yet the right time to exhaust assets just to repay shareholders. These stock-dividend paying companies are just taking safety measures because they don’t want to inflict any harm to their liquidity.