Stock Dividend Policy
There are several different types of dividends. The basic types of cash dividends are:
Other types of dividend options include:
The most common type of dividend is a cash dividend. Typically, public companies pay regular cash dividends four times a year. As the name suggests, these are cash payments made directly to shareholders, and they are made in the regular course of business.
Sometimes, firms will pay regular cash dividends and an extra cash dividend. By calling part of the payment “extra”, management is indicating that part of the dividend may or may not be repeated in the future.
A special dividend is similar, but as the name indicates, this dividend is viewed as truly unusual or a one-time event that will probably never be repeated, this type of dividend is given when the company receives a very unexpected windfall, such as a major lawsuit settlement.
The payment of a liquidating dividend usually means that some or all of the business has been liquidated, or sold off. The money from the sale is distributed to the owners or shareholders in the form of dividends.
Another type of dividend is paid out in shares of stock. This type of dividend is called a stock dividend. A stock dividend is not really a true dividend, because it is not paid. The effect of a stock dividend is to increase the number of shares that each owner holds. Since there are more shares outstanding, each share is simply worth less.
A stock split is essentially the same thing as a stock dividend. When a stock split is declared, each share is split up to create additional shares. For example, in a three-for-one split, each old share is split into three new shares.
A less frequently used financial maneuver is a reverse stock split. In a one-for three reverse split, each investor exchanges three old shares for one new share. The new share is now worth the same as three old shares combined. The company’s financial statements do not change, and the value of the investment does not change. The reasons why a firm would execute a reverse split are as follows: (1) in having fewer shares, the transaction costs of buying and selling will be less for investors; or (2) potential investors like to see the price of shares within a certain range.
Some markets, like the NYSE, require a corporation’s stock to be above a minimum price in order to be traded n their exchange.
An alternative to paying a cash dividend is the stock repurchasing option. Stock repurchasing has become a major financial option in recent years and will likely continue to be an alternative to cash dividends. There is literally no major effect on the company or the investor when the company chooses a stock purchase versus a cash dividend. The outflow of money is the same, whether the company gives dividends or repurchases an equivalent amount of stock from the marketplace. For shareholders, theoretically, the market value of their stock goes down equal to the amount of the cash dividend, thus having no effect on the investors’ total worth.
Example:
If the XYZ Company is worth 1 million dollars and has 100,000 shares outstanding, then the stock value is $10 per share ($1,000,000 ¸ 100,000 shares = $10). If you have 100 shares of XYZ Corporation, and the stock is currently worth $10 per share, your worth in this company is $1,000 (100 shares x $10 = $1,000). Now, if the company decides to pay a $1 dividend ($1 x 100,000 shares), then the company will be worth $100,000 less, or $900,000 ($1,000,000 – $100,000). The value of each share is now worth $9 ($900,000 ¸ 100,000 shares = $9 each.) Investors now have 100 shares worth $9 each (100 shares x $9 = $900) plus $100 in cash from dividends, for a total of $1,000.
If the company opted for a stock repurchase of $100,000, then the company would be worth $900,000, and they would buy back 10,000 shares, making the value of each share now $10 ($900,000 net worth ¸ 90,000 shares = $1 per share). Thus, if you owned 100 shares as an investor, your worth in this company is the same (100 shares x $10 = $1,000). The only difference to shareholders with a stock repurchase is that they don’t have to pay the extra income tax. For the corporation, we can view the stock repurchase option as the company getting “leaner and meaner.”
XYZ Company
The Young Investor Webpage is funded in part by a grant from the Investor Protection Trust, www.investorprotection.org
Back to Young Investors' Webpage