Advantages & Disadvantages of Cash Dividends

Written by dennis hartman
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Investing in the stock market, despite its inherent risks, can be a way to profit as companies and industries grow. Besides being able to sell shares for a higher price that they paid for them, investors can also profit by receiving cash dividends, which are cash payments that some companies give to stockholders on a per share basis.

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Benefit for Stock Owners

Investors who own stock in a company that offers a cash dividend receive several benefits. The cash payment, which is either delivered annually or quarterly, provides additional, steady income that is not directly related to stock performance. Owners who want liquidity can hold shares longer, relying on cash dividends instead while waiting for share prices to rise. Finally, in the event that a stock loses value, cash dividends can help lessen the impact of the loss.

Cost to Companies

Companies that offer cash dividends make a substantial financial commitment to their investors. Each share earns a dividend, and large companies can easily spend millions of dollars on dividends. This is money that can't be reinvested in the company or spent elsewhere. Once a company offers a dividend, any decrease to the dividend can cause stockholders and analysts to see the stock as less appealing, and may encourage some stockholders to sell.

Incentive to Invest

Dividends offer an incentive for investors to place their money in one company rather than another. Offering a large dividend is one way for a company to raise a large amount of capital, or have greater success with an IPO, or initial public offering, when it first begins to sell stock. Companies may even raise their dividends to combat a downgraded rating and keep investors interested.

Tax Consequences

Receiving cash dividends has tax implications for stockholders, who must claim the dividend as investment income. Since cash dividends occur every year, this places an ongoing tax burden on the investor, rather than allowing the investor to choose when to pay taxes by selling the stock at an advantageous time. The tax on cash dividends also reduces the value of the payment and applies to the dividends whether or not the stock itself rises in value.

Alternatives

Not every company offers a cash dividend. Some offer no dividend at all, preferring instead to pour resources directly into the company to make share prices rise as much as possible to benefit stockholders in the long term. Others offer a dividend reinvestment program, which automatically reinvests a shareholder's dividends into the company in the form of more stock. This type of dividend has the advantage of growing a stock owner's holdings and curbing losses. It also allows the shareholder to choose when to sell and face the tax consequences of capital gains or losses.

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