Question

The investment committee of your church has come to you for advice one of the stocks held by the church has paid cash dividends for years. This year the company issues a stock dividend so that the church received additional shares rather than cash. The committee is concerned about whether this stock dividend is really worth anything. One committee member argues the stock dividend is as good as cash; another argues that the dividend is worthless.

Write a brief report to the committee explain the difference between a cash dividend and a stock dividend. Evaluate the value of stock dividend compared with the cash dividend the church has received in prior years.

Answer 1

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.

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.

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.

Comprision:

Cash dividends are beneficial, however, in that they provide shareholders with regular income on their investment. Share bonuses, on the other hand, is an increase in the amount of shares of a company with the new shares being given to shareholders.