Cash Dividends vs. Stock Dividends
Cash Dividends vs. Stock Dividends
Investors have many different ways to be rewarded, such as stock price appreciation, which is based on investors bidding up the stock price higher. Stock price appreciation occurs because the business continues to grow and investors want exposure as a result.
Another method which can be used to reward shareholders is by acquiring cash or more shares of the company in the form of a cash dividend or a stock dividend. These provide exposure to the company’s growth without having to sell shares while being rewarded at the same time.
And just what is the difference between a cash dividend and a stock dividend? Well, a cash dividend is a payment that is made in cash to shareholders of the company. This is paid out to investors using the business’ earnings. A stock dividend, meanwhile, is more shares given to investors on top of those they already own.
This article will go through further differences when it comes to cash dividends vs. stocks dividends and how you, as a shareholder, would benefit or be at a disadvantage. The info includes how taxes will affect dividend payments and how to be eligible to receive a dividend.
How to Calculate Cash Dividends
A cash dividend payment is on a per-share basis and will differ for each company.
The number of times a dividend is paid throughout the year will determine how to calculate the dividend. For example, a company that pays a dividend twice a year would require the semi-annual payment to be multiplied by two. So, if that company paid a semi-annual dividend of $0.88 per share, the annual dividend would be $1.76 (2 x $0.88 = $1.76).
If a business pays a quarterly dividend, then the dividend must be multiplied by four. So if a business pays a quarterly dividend of $0.20 per share, this would mean an annual expected dividend of $0.80 per share. (4 x $0.20 = $0.80).
How to Calculate Stock Dividends
A stock dividend is based on a percentage and results in an increase in the number of shares owned. For instance, if a company issued a 10% stock dividend, it would mean that a shareholder now owns 10% more shares, or one additional share for every 10 already possessed. So, owning 1,000 shares prior would give you an additional 100.
Why Would a Company Issue a Stock Dividend Vs. Paying a Cash Dividend?
A stock dividend would be given to shareholders for a few reasons, the first being to reward them without harming the company’s own cash position. Stock dividends also don’t require any taxes to be paid until the position is sold. More information regarding this is further below.
With a stock dividend, shareholders have a choice: either keep the shares or sell them if they would rather cash out. They can also purchase more shares with a cash dividend, but this requires the shareholders to do some administrative work. Many do not take advantage of purchasing more shares with the cash dividend.
Companies that issue a cash dividend do so because they tend to have predictable recurring revenue from operations. They have a lot of free cash flow and there are not a lot of opportunities to use all that cash up in the form of investment opportunities. As such, shareholders receive a cash payment.
Cash dividend stocks look to attract long-term investors and the volatility on average is less than the overall market. Typically, management’s goal is to return wealth through cash dividends and share price appreciation in a balanced return approach.
Benefits of Receiving a Cash Dividend
As an investor receiving a cash dividend, the choice regarding what to do with the money is entirely up to you. You can use the cash dividend to pay your expenses, purchase more shares of the company, or even purchase shares in a different company altogether.
If you are a patient long-term investor, you may seek to earn steady income without selling any of your shares. This way, you can participate in the growth of the company and see the affect that growth has on your net worth.
A great thing about earning a cash dividend is that a continuous income is earned, no matter how the market is performing. And it stays this way as long as the company continues to pay its dividend.
Since cash-dividend companies have an obligation to pay a dividend, they must ensure their financial position is strong enough to support it.
Disadvantages of Receiving a Cash Dividend
One big disadvantage of receiving a cash dividend is that it needs to be accounted for when filing your tax return, maybe even moving up a tax bracket as a result.
A company may also not have enough cash to pay the dividend and is using debt to pay investors. This weakens a shareholder’s financial position company and could affect the share price. And since cash is leaving the business, there is less money being used for acquisitions or expansion.
Companies paying a cash dividend require that money to be set aside for that purpose. Unfortunately, this is money that isn’t doing anything to benefit the financial statements.
Benefits of Receiving a Stock Dividend
When receiving a stock dividend, there is no need to report this information when filling out your tax return right away; only when the position is sold do the dividends need to be reported for tax purposes. More information on this is below.
If you are a big believer in the business’s future growth, owning more shares could be exactly what you were looking to do with the dividend. Every time there is a stock dividend issued, you would be averaging your cost basis of the position. With this method, there is no need to time the market to purchase more shares of the company.
As you receive more stock dividends, your amount of shares should increase due to compounding. Take the earlier example using 1,000 shares of a company with a 10% stock dividend. That example ends with you owning 1,100 shares. Well, if the stock dividend is still around 10% next time, you would receive an additional 110 shares, for a new grand total of 1,210 shares. This trend, too, would continue as long as a stock dividend is being paid.
As for the company’s financials, its cash position will remain the same, since more shares are being issued. The cash could be used for expansion of the business or an acquisition.
Disadvantages of Receiving a Stock Dividend
If you were to receive a stock dividend but you require cash, then shares would have to be sold. This would include a commission cost and taxes. And, since you are in the need of cash, you may sell the shares at an unfavorable price–potentially even less than the amount of the stock dividend that was paid out.
When it comes to portfolio management, the disadvantage is that, as you gain stock dividends, the one position could start to account for a larger position in your portfolio. This may result in you trimming your position, which again will incur commission costs and taxes.
Receiving more shares could almost mean taking on more risk, should there be a change in business strategy and/or senior management. These moves could be seen as a negative by the market—and as a big disadvantage against a cash dividend—since you have just accumulated more shares.
When a stock dividend is paid out to shareholders, there are more shares issued by the company. This results in more shares outstanding, meaning each share is worth less of the company. For investors looking to build a new position in the company, this is seen as a big negative.
One last disadvantage for investors would be the self-interest of company insiders if a large amount of shares are owned. This would be because a large amount of their personal wealth is held within the company and they want to enjoy the advantages of a stock dividend, such as not paying taxes immediately.
How to Be Eligible to Receive a Cash or Stock Dividend
In order to receive a cash or stock dividend, the shares must be owned by certain dates. The dates are determined by the board of directors of the company and are announced well in advance, so investors can decide if they would like to receive the dividend payment or not.
Below is an example of the dates that are associated with a dividend payment:
|Terminology of Each Date||Declaration Date||Ex-Dividend Date||Record Date||Payment Date|
|Dates Associated with a Dividend Payment||March 20||April 15||April 17||May 11|
Declaration Date: This would be the date that the board of directors approves the dividend payment. It is also the date that an announcement is made to inform investors of when the shares need to be owned by and when the dividend will be paid out.
Ex-Dividend Date: I would say this is one of the most important dates that is associated with a dividend payment. The ex-dividend date is the cut-off date in order to be eligible to receive the dividend payment. Based on the chart above, the shares would have to be owned by April 14 or earlier in order to receive a dividend. If the shares were purchase on April 15 (ex-dividend date) or later, there would be no dividend received.
Record Date: This is the date that the company records all eligible shareholders that will receive a dividend. The company also records the number of eligible shares and the total amount of dividends to be paid.
Payment Date: Lastly, this is when the dividend payment is scheduled to be received.
Cash Dividend vs. Stock Dividend Tax
When a management team decides to pay a cash dividend or stock dividend, one factor in the decision-making process is how taxes will be applied. There is some overlap when it comes to taxes on cash dividends and stock dividends, and one case in which no taxes have to be paid.
If there is no choice but to receive a stock dividend, then there is no need to account for taxes. As noted earlier, taxes only need to be accounted for when the shares are sold, meaning stock dividend taxes could be delayed for years, should the investor so decide.
When the day comes and you decide to sell your shares, then capital gains taxes are applied. If the shares are held for less than one year, then a higher tax rate will be applied, as the Internal Revenue Service (IRS) will look at the transaction as a short-term capital gain.
But if the shares are held for more than a year, they are defined as a long-term capital gain and a more favorable tax rate is applied. It is important to keep a record of the length of time that an investment is held, because a lot of money could be saved in taxes.
When it comes to paying tax on cash dividends, there is the matter of qualified dividends vs. non-qualified dividends. Qualified dividends result in a more favorable tax rate when compared to non-qualified dividends.
Below is a table of the different tax rates that will be applied, depending on your income level and on whether the gain would be classified as a short-term or long-term capital gain. You will also find how taxes are applied on cash dividends.
|Single Reported Taxable Income||Married Filing or Qualifying Widow(er)||Married Filing Separately||Head of Household||Tax on Short-Term Capital Gains||Tax on Long Term Capital Gains||Tax Rate On Qualified Dividend Stocks||Tax rate On Non-Qualified Dividend Stocks|
|$415,051 or more||$466,951 or more||$233,476 or More||$441,001 or more||20%||39.6%||20%||39.6%|