Cash vs. Stock Dividends

by InvestmentFatCat – 11/01/ 2011

Although almost all companies pay dividends in cash, there are a few who pay dividends in stock. Jim Fink at Investing Daily reviews how a company pays a dividend in stock instead of cold hard cash

A stock dividend is similar to a stock split — a company issues new shares to stockholders in some proportion to the shares outstanding. Any stock dilution of 25% or greater is considered a split, so a 5-for-4 exchange is a stock split, not a stock dividend. Stock splits simply reduce the par value per share of stock outstanding. In contrast, stock dividends require the shifting of retained earnings into the company’s capital stock account, which reduces the cash available to pay out classified as a dividend. Cash paid out that is greater than retained earnings is classified as a return of capital.

Most stock dividends are in the 5% to 15% range. If a company pays a 5% stock dividend, each shareholder will receive one new share for every 20 shares they own. So a shareholder with 100 shares will own 105 shares after the dividend is paid. The total value of the firm does not change

Although there are some tax benefits to stock dividends, Mr. Fink does a good job summarizing why, when it comes to dividends, cash is king

Cash dividend proponents (including me) argue that requiring a company to return cash imposes fiscal discipline and prevents the company from squandering shareholder wealth. Furthermore, since many shareholder recipients of cash dividends do not reinvest them (silly them!), those that do reinvest gain a greater share of future company profits. And if you reinvest the cash when the stock price is low, all the better!

In contrast, recipients of stock dividends cannot increase their ownership stake in the company without shelling out additional cash from their pocket.