COM 104 Lecture Notes - Lecture 13: Ordinary Income, Making Money, Tax Bracket
27 Jun 2018
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Stock Dividends
What Is a Cash Dividend?
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 by
roughly the same amount as the dividend.
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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.
What Is a Stock Dividend?
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. Companies may decide
to distribute this type of dividend to shareholders of record if the company's
availability of liquid cash is in short supply.
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.
One key 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 a cash-dividend option, even if the shares are kept instead of the cash.
Cash vs. Stock Dividends
For stock investors seeking instant gratification as a reward for having placed their
funds in profitable companies, it would seem that receiving a cash dividend is
always the better option. However, this is not necessarily true.
In many ways, it can be better for both the company and the shareholder to pay
and receive a stock dividend at the end of a profitable fiscal year. This type of
dividend is as good as cash, with the added benefit that no taxes have to be paid
when receiving the same.
For example, one hundred shares of Microsoft bought at $21 per share in 1986
ballooned to 28,800 shares after 25 years. This turned Bill Gates into the richest
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
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 by 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.
