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As explained in the previous article, paying dividends is how a company shares its profits with shareholders, and dividends can be paid in cash or in shares. So, comparing cash dividends with stock dividends, which is more beneficial? I will analyse this from 2 angles: the investor’s and the company’s.
The investor’s perspective
Mathematically, paying a dividend does not increase shareholders’ wealth, because under the rules the share price must be adjusted accordingly. For example, if a company decides to pay a 10% cash dividend, i.e. VND 1,000 per share, and the stock’s market price is VND 46,000, then in the ex-dividend trading session the stock’s reference price is adjusted down to VND 45,000, so that total wealth before and after the dividend is the same.
The same applies to stock dividends. If a company pays a 15% stock dividend, every 100 shares receive 15 additional shares. On the ex-dividend date, the share price is adjusted down to 46,000*100/115 = VND 40,000, so that total wealth before and after the adjustment is unchanged.
Dividend payments therefore do not affect your portfolio in the short term. Long-term, accumulation-style investors care more about the dividend yield and whether dividends are paid consistently. They usually prefer cash dividends, because they are more certain and provide a cash flow for personal spending or for investing in other assets. The weakness of cash dividends, however, is that you cannot sidestep the tax the way you can with stock dividends.
In addition, a company’s dividend policy affects its development plans, its long-term revenue and profit, and directly affects its share price. We therefore also need to analyse it from the company’s perspective, to see whether the dividend policy is good or bad for the business and how it will affect the stock in the long term.
The company’s perspective
Paying dividends in cash
A company uses part of its profit after tax to pay dividends to shareholders and reinvests the rest in future plans. To pay cash dividends, a company therefore needs to generate sustainable profits and stable cash flow. Such companies are usually large players in their industry with a long history, often at a mature stage where further expansion is not possible. After a period of growth in which all cash is reinvested, this is when shareholders get to “enjoy the fruits” in the form of dividends, because the company no longer needs to reinvest.
Examples in the market include Vinamilk (VNM), Dam Sen Water Park (DSN), etc.
Does that mean it is bad for other companies to pay dividends? Not necessarily. If a company wants to expand but does not need much money to do so, it can still pay dividends at a reasonable rate. A company should not pay cash dividends when it urgently needs capital to expand, when it is in financial difficulty (generating little profit or cash flow), and, worse still, it should never borrow to pay dividends (that puts obligations to shareholders ahead of creditors, the opposite of the normal principle).
Paying dividends in shares
On the plus side, paying dividends in shares lets the company keep its cash to overcome difficulties or expand production, investing in projects that bring long-term returns to shareholders. These are usually companies that need rapid growth and are fighting for market share in their industry.
Paying stock dividends increases the number of shares outstanding, which indirectly increases the stock’s liquidity. Stock dividends also lower the market price, making it easier for more investors to buy the stock.
Stock dividends are even more attractive if the company is expanding its investments. In that case, investors will see their cost per share fall much faster with stock dividends than with cash dividends.
However, if the company’s business is not outstanding and it invests in ineffective projects, the share price will fall further. Investors also need to assess the company’s finances. Some companies use financial tricks to make their business results look good without generating cash flow. High profits that sit largely in receivables, assets in progress and the like signal a cash flow problem. Paying stock dividends then becomes a way for the company to legitimise various financial metrics, which is completely different from investing for expansion. The company’s shares are heavily diluted, and with such weak finances it will be hard for the share price to recover or for the company to pay a high dividend the following year.
Happy trading!
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