The dividend dilemma: Exploring the impact of stock and cash dividends on stock prices

At the outset of the new business year, publicly listed companies are preparing for their annual general meetings (AGMs), significant events where those demonstrating robust financial performance from the previous year may declare dividends.

This prompts the question: what type of dividends will a company distribute to its shareholders? A company has the option to distribute either stock dividends, cash dividends, or a combination of both. Stock dividends and cash dividends represent two distinct avenues through which companies allocate profits to their shareholders. Below, we provide a comparative analysis of these methods and their potential impact on prevailing stock prices.

Stock Dividends:

Stock dividends involve the issuance of additional shares of the company's stock to existing shareholders, typically on a pro-rata basis. For example, a company might declare one additional share for every ten shares held by a shareholder.

Unlike cash dividends, stock dividends do not involve the distribution of cash; instead, they signify a transfer of retained earnings into the company's equity capital.

From the shareholders' perspective, receiving stock dividends increases the number of shares they hold but does not alter the overall value of their investment.

For instance, if a shareholder owns 100 shares of a company's stock valued at Ghs50 per share before a 10% stock dividend, they would receive 10 additional shares, yet the total value of their investment remains unchanged.

Stock dividends are often perceived as an indication of the company's confidence in its future prospects, signaling reinvestment of profits into the business rather than cash distribution.

Cash Dividends:

Cash dividends involve disbursing a portion of the company's profits to shareholders in the form of cash payments. The dividend amount is typically specified as a fixed sum per share (e.g., Ghs0.50 per share).

Cash dividends provide shareholders with immediate cash returns on their investment, which they may utilize for consumption, reinvestment, or other financial endeavors.

Income-oriented investors, seeking regular income streams from their investments, typically favor cash dividends. Additionally, cash dividends may attract investors seeking stable returns and dividend yield.

Impact on Current Stock Prices:

The impact of stock dividends and cash dividends on current stock prices can fluctuate depending on various factors, including investor sentiment, market conditions, and the company's financial performance.

Stock dividends, by increasing the total number of shares outstanding, dilute the ownership stake of existing shareholders. However, since stock dividends do not alter the overall company value, their impact on the stock price per share is often minimal. In some instances, the announcement of a stock dividend may result in a temporary decrease in the stock price due to perceived dilution by investors, although this effect is typically short-lived.

Conversely, cash dividends typically deplete the company's retained earnings and cash reserves. While cash dividends may be well-received by income-oriented investors, large or unexpected cash dividends could signal to the market a lack of profitable investment opportunities or financial challenges. Cash dividends affect current prices on the ex-date because share prices represent future cash flows of the company, meaning future dividend payments are incorporated into the share price.

For details, the use of discounted dividend models can help analyze a stock's value in the market. Consequently, the impact on the stock price per share may vary, with some investors interpreting cash dividends positively and others viewing them as a negative indicator of the company's future prospects.

Overall, while both stock dividends and cash dividends can influence shareholder wealth and investor sentiment, their impact on current stock prices hinges on various factors and may differ from one scenario to another.

For a deeper understanding of this subject and further assistance kindly contact EcoCapital Investment Management Ltd., on +233(0)501 553 502 or send us a mail via invest@ecocapinvestment.com.

EcoCapital Investment Management Limited (EIML) is a company incorporated in Ghana and licensed by the Securities and Exchange Commission (SEC) as an Investment Management firm, and by the National Pensions Regulatory Authority (NPRA) as Fund Manager of both second and third tiers of the national pension scheme.

The corporate mandate of the firm is to deliver premium financial solutions and investment management services to both retail and institutional investors in Ghana. Services on offer at EcoCapital include: Wealth Creation and Management, Investment Portfolio Management, Pension Fund Management, Mutual Funds, Retirement Planning, Investment research and Advisory. The firm has three mutual fund products under management, namely; Prime Fund, Nordea Income Growth Fund and the Weston Oil and Gas fund.

Written By:

Dela Herman Agbo, MBA, MSc, CGIA

Chief Executive Officer

EcoCapital Investment Management Ltd.