Stock Dividends vs. Cash Dividends

As an investor, it’s essential to understand the difference between stock dividends vs. cash dividends. Companies use both dividend types to reward stockholders for their investments. 

They’re typically issued at the end of an earnings period, whether quarterly or yearly. However, the type of dividend chosen will have different implications for the recipient and the company.

What Are Stock Dividends?

A stock dividend provides an investor with additional shares in the company. Recipients may receive fractional shares proportionate to their existing holdings or total shares. Stock dividends increase the stockholder’s proportionate ownership of the company. 

Stock dividends are less common than their counterpart, cash dividends. The companies that use them are typically growing organizations that don’t have a lot of cash to spare and want to increase the number of shares available on the market. Organizations facing financial difficulties sometimes switch from cash dividends to stock dividends to save money.

Stock dividends carry some risk since there’s no guarantee that the stock will gain value. If share prices fall, the stock dividend will lose its value. However, if share prices increase, the shareholder can sell their stock dividends and earn a return on their investment.

Since no money is exchanged between the company and the recipient, there are no immediate taxes on stock dividends. Instead, the stockholder will incur taxes when selling their stock on the market. 

Pros:

• Stock dividends provide the shareholder with more ownership in the organization.
• Shareholders can decide to keep or sell their new shares.
• Stock dividends aren’t taxable until they’re sold.

Cons:

• There’s no guarantee the share price will rise.
• The choice to buy or sell is up to the shareholder, which results in behavioral risk.
• The issuing company may be in financial distress.

What Are Cash Dividends?

Companies that issue cash dividends reward shareholders with a small amount of cash for each share they own after a profitable quarter or year. Instead of reinvesting the profits into the business, the company distributes a portion of its earnings to investors.

The amount of the dividend is issued on a per-share basis. For example, someone who owns 300 shares of stock in an organization that administers a $0.10 dividend would receive a cash bonus of $30. They could use the money to buy additional shares in the organization or accept it as cash.

Organizations that issue cash dividends are established companies past the startup stage. They have a strong balance sheet and customer base and a history of profitability. Once a company begins issuing cash dividends, investors expect them to continue doing so. Stopping may indicate that the organization is under financial strain.

The money for cash dividends comes directly from the company’s profits. Once the organization declares the dividend, it can’t reinvest the money into its business operations. A company’s market capitalization value typically sinks in proportion to the total dividend declared.

Unlike stock dividends, cash dividends are fully taxable to the recipient. The tax paid on the dividend depends on the length of time that the stockholder owned their shares. Lengthier ownership entitles the investor to reduced income tax rates, while a shorter ownership period taxes dividend recipients according to their ordinary income tax brackets.

Investors seeking a regular source of income are attracted to dividend-issuing companies. 

Pros:

• Source of regular income to the shareholder
• Option to repurchase additional shares in the company using the cash dividend
• Companies that issue cash dividends are typically established and stable.

Cons:

• All cash dividends are subject to tax.
• Cash dividends prevent the reinvestment of profits back into the business.
• Income can be unreliable.

Key Differences Between Stock Dividends vs. Cash Dividends

There are several differences between cash and stock dividends that investors should understand.

Timing of Payment

The timing of payment for stock and cash dividends differs. A cash dividend results in an immediate reduction in the company’s cash flow. Once it issues the dividend, the money goes directly to the shareholder, who can use it to buy additional shares or simply accept it as income.

In contrast, a stock dividend doesn’t directly impact the organization’s cash flow since there is no outflow of money. An investor who receives the stock dividend can hold onto it or sell it immediately on the open market at the current share price. If the share price increases, they’ll receive an additional gain on the value of the sold shares. If it falls, they’ll incur a loss.

Impact on Ownership Stake

Investors who receive a stock dividend increase their ownership holdings in the company without buying additional shares. For example, suppose that a company provides a stock dividend of two shares for every share held. An investor who owns five shares in the organization will receive an additional 10 shares through the dividend, increasing their ownership to 15 total shares.

Cash dividends don’t impact the investor’s ownership percentage, which means that the investor doesn’t receive additional shares through the dividend. However, they can use the cash they receive to buy more shares in the business if they like. 

And if they do so, they’ll see an increase in their ownership of the company. If not, they can use the dividend to supplement their income.

Flexibility in Using Dividends

Shareholders who receive stock dividends have two options: sell their new shares on the market or hold them until later. If they sell, they’ll receive an immediate cash benefit. Holding the shares can lead to a future gain or loss.

Cash dividends provide investors with much more flexibility. The recipient can use the dividend to purchase more shares in the company or accept the dividend as additional income. They can also use the dividend for other investment opportunities, like buying stock in other companies or putting the money in a high-interest savings account.

Involvement of Cash Reserves

Companies that issue a stock dividend see no impact on their cash balance. The stock passes from the organization to the investor but does not change the company's current monetary balances.

A cash dividend automatically reduces the cash reserves of an organization. The company issues the dividend from its existing cash balances.

Risk and Volatility

Stock dividends result in some risk to the investor. Since share prices can go up or down, the value of the dividend will fluctuate. They’ll need to decide when to sell their shares and may incur a loss if the stock price falls.

Cash dividends have less exposure to market volatility. The investor can keep the money they receive or reinvest it in new shares. 

Tax Implications

A stock dividend has no immediate tax consequences for the recipient. They’ll only incur taxes when they sell their shares on the market at a gain. In contrast, cash dividends are subject to either ordinary or qualified dividend taxes, depending on the length of time the stockholder owns their shares.

Individual Financial Goals and Circumstances

Investors seeking a long-term investment strategy typically prefer stock dividends since they know they can hold onto them for as long as they like. Holding stock can result in significant gains for the investor if the company grows and share prices increase. 

However, cash dividends are better for investors who have shorter-term financial goals. For instance, a retiree may prefer cash dividends to supplement their income.

Both Cash and Stock Dividends Have Benefits

Deciding between an organization that issues cash or stock dividends boils down to your financial goals. Stock dividends carry more risk, but they also have the potential to increase in value over time. Cash dividends offer immediate benefits, and investors have flexibility in how they choose to use them.

Frequently Asked Questions