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It doesn’t matter if you are a rookie or a guru in the financial sector, one must always try to explore new possibilities and investment opportunities as well as have a sound and solid plan of action how to stay “on board.”
Investing in dividends is something practiced by many financial players. However, what is a dividend? Which are the two main types? What are their characteristics? Are there any risks associated with cash and stock dividends?
To start with, let’s define dividend:
This is a portion of a company’s earnings given to all shareholders. There are mainly two types of dividend – cash and stock. The former is the most commonly used method of sharing corporate profits, while the latter is not as common though as worth discussing and considering.
Below you will find the two types discussed, as well as more details that would help you to decide: dividend investing – cash or stock?
This dividend is normally distributed to stockholders, of course in cash, out of a company’s earnings. So, imagine you have 2 shares in company X. The board of this business decides to pay 1 USD a share per year. Now, as a (smart) investor, you have 2 USD in dividends.
What does this mean and what can you do?
Well, money is money. For sure, it gives you liquidity. They provide regular cash income and are also a great way for reinvestment. Once paid out, the company’s market performance cannot have an impact. One dollar is one dollar in your pocket.
Unfortunately, this transfer of economic value (from a company to investors) causes a drop in the stock price of the shares, which is something you own. Another negative aspect of cash dividends is that they are taxable – every person who receives them should pay tax on the money.
This is a payment made in the form of shares instead of currency. For this purpose, company X has to increase the number of its shares, which are used for distribution to its investors. What can they do once they’ve got them?
Experts claim that this type of dividend gives investors flexibility – if you have new shares you can sell them right away, thus receive fresh cash. Or you can sell them in the future.
Definitely, in the long-run stock dividends are much preferred to their cash counterpart, which gives immediate liquidity. In addition to that, the new shares are not taxed unless sold by investors. However, the business environment and financial markets are quite unpredictable and volatile.
If company X faces problems and subsequently the price of its shares plummets, it means your shares within the company would have the same faith. This a serious risk to consider when choosing stock dividends.
Which One do Companies Prefer?
Let’s think about and discuss the mechanism behind those two types of a dividend. To a business, there is not much difference if it has to pay its shareholders in cash or stock dividends.
A company decides to disburse 1% of its earnings to its stockholders as a dividend. It doesn’t matter if this is paid out in currency or its respective value in shares. 100 dollars are 100 dollars.
However, there is one thing we should take into account – a company’s purchasing power.
What does this mean?
Now, if company X wishes to distribute dividends to its investors in cash, it loses part of its liquidity. Therefore, a business has less money to operate with, which could be crucial if they want to expand or invest in innovation or research. Not having enough liquidity could pose a serious threat to businesses such as banks or other lenders.
Who Wins The Battle In Dividend Investing – Cash Or Stock?
The answer to this question is left to you as an investor. If you have a sound plan and know how to “play your game,” perhaps both ways are a good choice.
For example, a cash dividend does not mean strictly money – you can reinvest back in the company using a reinvestment dividend plan. Despite that, most financial experts think that stock dividends are a better option. Not only can you use them as cash dividends if sold immediately after acquiring but also they can present a long-term investment perspective.
We should not forget the symbolic value of such decision– if the owners of a corporation invest back in it, that’s a good indicator and adds symbolic meaning and significance to the image of a business. Last but not least, let’s look at what Richard Russell had to say about stock dividends.
“A stock dividend is something tangible — it’s not an earnings projection; it’s something solid, in hand. A stock dividend is a true return on the investment. Everything else is hope and speculation.”