Difference Between Stock Dividends And Cash Dividends

Because equity shareholders are the owners and managers of a company, they have a right to the company's profits. Dividends are a way for shareholders to receive the company's profits. Many investors choose to invest in dividend investing because they provide steady income to equity shareholders.

A company does not have to distribute its profits through cash dividends. Stock dividends are another way a company can distribute its earnings to equity shareholders. If you are looking to invest in dividends, it is important to understand the differences between stock dividend and cash dividend. This is a detailed overview of the cash dividend and stock dividend.

What's a cash dividend?

Investors and financial professionals often refer to cash dividend when they use the term "dividend". Cash dividend is when a profit-making company pays dividends to shareholders in cash. This example will help you understand the concept better.

Let's say there is a company ABC Limited. The company has approximately 1,00,000. Equity shares have been issued. For the financial year 2019-2020, the company earned a net profit of Rs. 20 lakhs. The company decides that it will distribute its entire profit to shareholders. The company decides to pay cash dividends for each equity share it issues.

Dividend per equity stock = Net profit / Total number of equity shares issued

Dividend per equity shares = Rs. Dividend per equity share = Rs. 20/-

This is a classic example for cash dividends, as the company decided to split its profits in cash.

What is a stock dividend?

Now that you know what cash and are, let's take a closer look at stock dividend.

Stock dividends are when a company decides to give its stock to its equity shareholders, regardless of whether it is profitable. This happens in return for their investment. This is an example of stock dividends to help you understand the concept better.

Let's all take over the same company ABC Limited. The company has already issued approximately 1,00,000. The company decides that it will pay a dividend to its equity shareholders. The company's net profits are not sufficient to pay cash dividends to its equity shareholders. So the company decides that it will distribute its unissued equity shares among its equity shareholders. The company distributes a 10% stock dividend its equity shareholders.

The company would then have to issue an additional 10,000 shares (1,000,000 equity shares x 10%) to its equity shareholders. For every 10 equity shares a shareholder holds, 1 equity share would be paid as a dividend. Investors have the option to either keep the stock or sell it at the current trading prices. This is an example of a stock dividend.

Difference in cash dividend and stock dividend

Now that you are familiar with the differences between stock dividend and cash dividend, let's look at what they mean. Below are the main differences between them.

Involvement in cash reserves:

This is the biggest difference between stock dividend and cash. Cash dividends are paid by a company to its equity shareholders. This involves accessing the cash reserves of that entity. Cash dividends are the payment of profits to shareholders, rather than being reinvested back into the business.

With stock dividends, however, a company does not have to draw on its cash reserves or make any profits, as it is issuing its stock to its equity shareholders.

Company Repercussions:

A company that taps into its cash reserves to issue cash dividends for its equity shareholders can end up draining its funds. This can sometimes be detrimental for a company as it is unable to tap into its cash reserves for emergencies.

Contrary to popular belief, cash reserves of companies remain intact in the event that stock dividend distributions are made. The company can, however, issue more shares to existing shareholders which could lead to a decrease in ownership.

Shareholder Repercussions:

The way the shareholder is affected by the stock dividend and cash differs from stock dividend. A cash dividend is an income that an equity shareholder receives from a company. The shareholder must disclose this income and pay taxes.

However, a stock dividend is not considered income and therefore does not attract taxation. However, the shareholder would still have to pay taxes if he sold his shareholding on the open market as that would be deemed revenue.

Conclusion

These are the main differences between stock dividend and cash dividend, as you can see by the three points above. Cash dividends might be the best option for investors looking for steady income. It is less risky.

If you are an investor who takes a lot of risk and is interested in capital appreciation and capital growth, then investing in companies that regularly pay stock dividends might be the best option. There is no clear winner when it comes cash dividend vs. stock dividend. It all depends on each investor's preferences.