The return earned on equity securities has two components: dividends and price appreciation. Dividends represent the distribution to investors on a per-share basis.
Cash dividends vs stock dividends vs stock splits
There are two types of dividends: stock dividends and cash dividends. A stock dividend (also called the issue of bonus shares) is a distribution of new shares to existing shareholders. They have no valuation implications because they just divide the existing market value of equity into a different number of shares, just like a stock split or a reverse stock split. Cash dividends, on the other hand, represent actual payout of cash to investors.
Companies try to smooth the payment of dividends i.e. they tend to pay dividends which do not change abruptly even when the operating performance fluctuates. Such dividends are called regular cash dividends. Sometimes companies do pay an extra dividend or special dividend, for example in case of cyclical companies or a restructuring.
Dividend dates: declaration date vs record date
When a company issues a statement announcing dividends, it is called the declaration date, which is followed by the ex-dividend date, a date on and after which, the shares trade without the dividend claim (resulting in a drop in the stock price of an amount equivalent to the dividend per share). On the holder-of-record date (also called record date, date of book closure, etc.) a list of shareholders who will get the dividends is prepared and the payment is made on the payment date.
Dividends vs share repurchase
An alternative to cash dividends is the share repurchase, a transaction in which companies buy back their shares. A share repurchase is equivalent to a cash dividend because it increases the stock price and results in a return for investors.
Reasons for share buyback include:
- signaling that the stock is undervalued and to support share price,
- flexibility in amount and timing of cash flows,
- tax efficiency when tax on dividends exceed tax on capital gains, and
- offsetting of the dilutive effect of stock options issued to management, etc.