- Summary
- Cash dividends pay shareholders in cash, while stock dividends provide additional shares instead.
- While cash dividends are taxable in the hands of investors, stock dividends generally do not create a tax liability at the time of allotment.
- From a liquidity perspective, cash dividends provide funds immediately, while stock dividends increase the number of shares without providing cash.
What is a dividend?
A dividend is a distribution that a company makes to its shareholders, generally from its profits. Cash dividends are usually announced as an amount per share and may be paid as interim, final or other dividends depending on the company’s policy.
Companies are not required to pay dividends every year. They may retain profits when the funds are needed for business operations, expansion or other purposes.
What is a cash dividend?
A cash dividend is a direct distribution of a portion of a company’s current earnings or accumulated profits paid out in cash through electronic transfer or cheque to its shareholders.
The cash dividends can provide a direct return on holding shares for the investors. The companies that regularly pay dividends may further appeal to investors who are looking for dividend stocks that can generate periodic income.
Advantages of a cash dividend
- A cash dividend acts as additional income for investors. It is one of the main attractions for investors to invest in the stock market despite all the risk it carries. It also allows investors to maintain liquidity and use those funds for personal requirements.
- Regular cash dividend payouts reward shareholders and increase their loyalty towards companies. Existing shareholders may choose to reinvest dividends or bring in larger investments when they receive dividends regularly.
- Paying cash dividends attracts new investors towards companies. The increased demand will have an impact on the company’s share prices.
- A company paying regular dividends in cash indicates that the firm is cash-rich and is performing well. This acts as a boost to the firm and may result in increased share prices.
Disadvantages of a cash dividend
- Paying cash dividends creates an opportunity cost for the company. The firm has to give up on the opportunity of reinvestment, which may have fueled growth.
- Paying dividends in the form of cash may exert undue pressure on the company to arrange for finances when in need. Companies may rely on debt and other options to meet financial commitments, leading to increased costs.
- Paying dividends for one period may set expectations among investors and the public that the company will continue to pay them. Non-payment in upcoming periods may reflect negatively on the company’s image.
- From the investor’s perspective, despite the benefit of earning regular income, they must pay taxes, which brings down the value of their earnings.
- Sometimes, paying dividends affects the stock prices of companies. It is noticed that stop prices drop at times after paying dividends. It may be because the company’s profits are reduced, which impacts the new investors.
What is a stock dividend?
A stock dividend is a distribution in which a company gives existing shareholders additional shares instead of paying them cash. It increases the number of shares held by an investor without requiring any additional investment.
Stock dividends are usually distributed in a specified ratio. For example, a 1:1 stock dividend gives an investor one additional share for every share already held.
In India, this concept is commonly associated with bonus shares, although bonus shares are legally treated as a separate corporate action and cannot be issued in place of a dividend under the Companies Act, 2013.
A stock dividend does not automatically increase an investor’s wealth because the share price generally adjusts for the increase in the number of outstanding shares. For example, if a company has 1,000 shares trading at ₹100 each, its market capitalisation is ₹1,00,000. After a 1:1 issue, there would be 2,000 shares and the theoretical adjusted price would be ₹50, leaving the initial market capitalisation unchanged.
Unlike a cash dividend, this type of distribution allows the company to retain cash within the business while shareholders receive additional shares.
Advantages of a stock dividend
- Issuing stock dividends helps companies retain their cash and use it on better options that promote growth.
- Stock dividends are beneficial for investors as they do not invite tax obligations, allowing investors to enjoy the entire value of their earnings.
- Stock dividends give investors additional shares at no cost. Though it does not increase their wealth instantly, they may reap the benefits of capital appreciation when shares perform well in the market.
- Stock dividends increase the quantity of shares, improving the stock’s liquidity in the market. High liquidity is a significant factor that influences investment decisions.
Disadvantages of a stock dividend
- Receiving dividends through stocks takes the opportunity of cash liquidity from investors. Those investors who plan to use their cash dividends for personal requirements may be disappointed with stock dividends as they do not increase their wealth instantly.
- There is no guarantee that stocks will perform well in the market. If their prices go down, investors lose the value of their wealth despite receiving additional shares for free. Cash dividends may feel better in such instances as wealth increase is assured.
- Issuing bonus shares means giving additional shares, thereby increasing the existing investor’s shareholding in the company. This may require the management to compromise further on the company’s ownership.
Cash dividend vs stock dividend
The table below provides a cash dividend vs stock dividend comparison across their key features:
| Cash dividends | Stock dividends |
| Dividends paid from the company’s profit in the form of cash | Dividends paid in the form of bonus shares at no additional cost to existing shareholders |
| Paid when the company has sufficient cash reserves | Paid when companies are short of cash or want to reinvest cash back in the business |
| Imposes tax liability on investors | Investors do not pay taxes on stock dividends |
| Suitable for short-term investors | Suitable for long-term investors |
Bottomline
Dividend payouts are one of the primary reasons for investors to choose stock market investments. While some people invest in stock markets for capital appreciation, others invest to earn dividends as an additional source of income.
Paying dividends through cash works well for companies when they have sufficient reserves and do not have plans to invest the entire profit into the firm’s growth. Conversely, in cases where companies want to reinvest profits back into the business, the concept of stock dividends works better.
Both forms of dividends offer certain benefits and limitations to investors and companies. It is suggested that investors assess the dividend track record of companies before deciding to invest.
FAQs
Cash dividends are payments made by companies to their shareholders from their current earnings or accumulated profits, which provide a direct monetary return to the investors on their shareholdings. The dividend is usually credited to their bank account when the company declares and pays it.
A cash dividend is when a company pays shareholders a portion of profits in cash directly to their bank account. On the contrary, a stock dividend provides additional shares instead of cash. Cash dividends provide immediate income, while stock dividends increase the number of shares held but do not provide instant liquidity.
When a company declares a cash dividend, its stock price falls by approximately the dividend amount on the ex-dividend date. This happens because the cash reserves of the company are reduced after the payout. But the long-term price movement depends on company fundamentals and investor sentiment.
A cash dividend refers to the actual payout made in cash to shareholders. A qualified dividend is a type of cash dividend that meets specific tax requirements and is taxed at lower capital gains rates instead of higher ordinary income rates. The difference lies in tax treatment, not in the payout method.
