Question

What are the reasons for a stock dividend instead of a cash dividend?

Answer 1

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For stock investors seeking instant gratification as a reward for having placed their funds in profitable companies, it would seem that receiving a cash dividend is always the better option. However, this is not necessarily true.

In many ways, it can be better for both the company and the shareholder to pay and receive a stock dividend at the end of a profitable fiscal year. This type of dividend is as good as cash, with the added benefit that no taxes have to be paid when receiving the same.

For example, one hundred shares of Microsoft bought at $21 per share in 1986 ballooned to 28,800 shares after 25 years. This turned Bill Gates into the richest man in the world. Many of Microsoft’s shareholders and employees who got shares of stock in the company's early years also turned into multi-millionaires.

One of the best reasons for giving a stock dividend instead of a cash dividend may be that in giving a stock dividend, a company and its shareholders forge psychologically stronger links, with the investor owning more of the company with the additional shares.

Stock dividends are thought to be superior to cash dividends as long as they are not accompanied with a cash option. Companies that pay stock dividends are giving their shareholders the choice of keeping their profit or turning it to cash whenever they so desire; with a cash dividend, no other option is given.

But this does not mean that cash dividends are bad, they just lack choice. However, a shareholder could still reinvest the proceeds from the cash dividend back into the company through a dividend reinvestment plan.

Opting for stock dividends is not always better than taking the cash due to the sometimes unpredictable nature of the stock market. Oct. 24,1929 will forever be remembered as the start of the Great Depression, the first day of a stock market collapse that crippled the United States for the next several years. Just days before, the Dow Jones appeared rock solid. During the Depression, most shares of stock were not worth the paper on which the stock certificates were printed.

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