Which is better a cash dividend or a stock dividend?

By Investopedia Staff AAA
A:

The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: cash and stock.

A cash dividend is a payment made by a company out of its earnings to investors in the form of cash (check or electronic transfer). This transfers economic value from the company to the shareholders instead of the company using the money for operations. However, this does cause the company's share price to drop my roughly the same amount as the dividend. For example, if a company issues a cash dividend equal to 5% of the stock price, shareholders will see a resulting loss of 5% in the price of their shares. This is a result of the economic value transfer. Another consequence of cash dividends is that receivers of cash dividends must pay tax on the value of the distribution, lowering its final value. Cash dividends are beneficial, however, in that they provide shareholders with regular income on their investment along with exposure to capital appreciation.

A stock dividend, on the other hand, is an increase in the amount of shares of a company with the new shares being given to shareholders. For example, if a company were to issue a 5% stock dividend, it would increase the amount of shares by 5% (1 share for every 20 owned). If there are 1 million shares in a company, this would translate into an additional 50,000 shares. If you owned 100 shares in the company, you'd receive five additional shares.

This, however, like the cash dividend, does not increase the value of the company. If the company was priced at $10 per share, the value of the company would be $10 million. After the stock dividend, the value will remain the same, but the share price will decrease to $9.52 to adjust for the dividend payout. The benefit of a stock dividend is choice. The shareholder can either keep the shares and hope that the company will be able to use the money not paid out in a cash dividend to earn a better rate of return, or the shareholder could also sell some of the new shares to create his or her own cash dividend. The biggest benefit of a stock dividend is that shareholders do not generally have to pay taxes on the value. Taxes do need to be paid, however, if a stock dividend has an cash-dividend option, even if the shares are kept instead of the cash.

Stock dividends are thought to be superior to cash dividends as long as they are not accompanied with a cash option. This is due to the choice that stock dividends offer compared to cash dividends. But this does not mean that cash dividends are bad, they just lack choice; a shareholder could still reinvest the proceeds from the cash dividend back into the company through a dividend reinvestment plan.

(For further reading, see How And Why Do Companies Pay Dividends? and Dividend Reinvestment Plans - Are They for You?)

RELATED FAQS

  1. How do I use the dividend capture strategy?

    Learn how to implement the dividend capture strategy, an aggressive, income-focused stock trading strategy investors can ...
  2. Why do utility stocks pay high dividends?

    Learn why utility stocks pay high dividends, and how government-produced monopoly authority protects privileged utility companies ...
  3. Why is it important to understand the Circular Flow Of Income when making investment ...

    Find out why investors should pay attention to a firm's circular flow of income model to measure its efficiency and evaluate ...
  4. What's the safest way to invest in high-yielding dividend stocks?

    Learn about some of the most important safety factors that you need to consider before you invest in high-yielding dividend ...
RELATED TERMS
  1. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  2. Paid-Up Additional Insurance

    Additional whole life insurance that a policyholder purchases ...
  3. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  4. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  5. Payout Ratio

    The proportion of earnings paid out as dividends to shareholders, ...
  6. Retention Ratio

    The proportion of earnings kept back in the business as retained ...

You May Also Like

Related Articles
  1. When most investors begin planning for a steady income stream in retirement, they tend to gravitate towards fixed-income as a predominant asset class.
    Mutual Funds & ETFs

    Funds That Should Be On Every Investor’s ...

  2. Though dividends are thought to realm of conservative investors, they deserve a place in all portfolios. Here are some of the best bets.
    Trading Strategies

    The Best Bets In Dividend Stocks

  3. Lifestyle inflation occurs when 'you earn more, you spend more', and your spending ends up matching your earnings. Thus, no savings remain.
    Budgeting

    Failing To Build Wealth Despite Making ...

  4. What is the difference between corporate bonds and preferred stock? The following are a list of pros and cons for each investment.
    Trading Strategies

    Preferred Stocks versus Bonds: How to ...

  5. How did investors select worthy alternatives so quickly given the majority of the assets were liquidated at a break neck pace following Gross’ resignation?
    Investing

    Why BOND Still Might Be In A Class Of ...

Trading Center