If an investor wants to reinvest dividends, aren't stock dividends better than cash dividends?

Question

When a company pays a cash dividend, the shareholders may need to pay income tax on that dividend. If a shareholder always wishes to reinvest the dividends, cash dividends have a few disadvantages:

• The shareholder always has to do work during dividend season to reinvest the dividends.
• The stock price is unlikely to be an exact multiple of the cash dividend, so the investor will have some cash left-over that is not reinvested.
• Dividends are tax-inefficient as mentioned above.

For such an investor, a stock dividend (as opposed to a cash dividend) may be a better choice because:

1. Dividends are "reinvested" automatically.

2. Whenever the investor needs cash, he/she can create a cash dividend simply by selling the extra shares given in the stock dividend. In effect, a stock dividend has an "optional cash dividend" within it.

I noticed that cash dividends are significantly more common than stock dividends. So my questions are:

• Are stock dividends really better than cash dividends for investors who want to reinvest dividends?

• Given the apparent efficiencies of stock dividends, why do companies continue to pay cash dividends and not stock dividends?

Answer 1

• I don't know of the American tax system, but I could imagine that on stock dividends, income tax would be due as well (not necessarily immediately, but at a later time).

• The argument

  The shareholder always has to do work during dividend season to reinvest the dividends.

  can be weighed against

  Whenever the investor needs cash, he/she can create a cash dividend simply by selling the extra shares given in the stock dividend. In effect, a stock dividend has an "optional cash dividend" within it.

  because, if you see it the other way: if you need cash, you don't need to do anything; if you want to re-invest, you can do so. (It's not so much work; it's usually just a matter of some clicks.) Besides, the 2nd argument can be reversed: "Whenever the investor doesn't need cash, he/she can create a stock dividend simply by buying shares. In effect, a "cash dividend" has an "optional stock dividend" within it." It's (kind of) the same amount of work.

• The stock price is unlikely to be an exact multiple of the cash dividend, so the investor will have some cash left-over that is not reinvested.

  That's right, but personally, in this case, I'd just fill up with additional funds.

A third option (which some companies indeed choose) would be to pay no dividend at all or to pay a very small dividend. In this case, the increasing value of the company is reflected by increasing stock price. Remember that the value of a stock drops about the amount of the dividend when the dividend is paid.