Dividends are vital to an investor’s total return from owning stocks. They offer a consistent income stream and can be rewarding to participate in a company’s profits. However, when it comes to dividend payouts, we are sometimes faced with a choice: should we opt for cash dividends or scrip dividends (also known as stock dividends)?
What is a Scrip Dividend?
A scrip dividend is a distribution made by a company to its shareholders in the form of additional shares of the company’s stock rather than cash.
Unlike cash dividends, which provide shareholders with immediate income in the form of money, scrip dividends increase the number of shares an investor holds without involving any monetary transaction.
What is the difference between cash and scrip dividend?
| Cash Dividend | Scrip Dividend | |
|---|---|---|
| What you receive | Cash | Shares |
| Potential for capital appreciation | No | Yes |
| Have to deal with odd lots | No | Yes |
Case Study: Cash vs Scrip Dividend
To illustrate this process, consider a straightforward example. Imagine you hold 1000 shares as a stakeholder in company A, which is presently offering a dividend of $0.10 for each share. If you were to choose the cash dividend, you would receive a sum of $100 directly deposited into your account.
However, in the case that company A decides to present a scrip dividend option, and you opt for it, taking the issue price for the new shares is set at $2 (typically determined as the average price over a specific timeframe), you as an investor would then receive 50 additional shares in your brokerage instead of the cash.
Why do listed companies offer scrip dividends?
You must be thinking now, why do companies make investing so complicated?
Well, scrip dividends are not an uncommon practice as companies, including our three local banks DBS, OCBC, and UOB, along with others like CapitaLand Limited, Singtel, and Raffles Medical Group, have in the past offered scrip dividends.
Of course, these companies may have different motivations for doing so. However, the central driver typically revolves around the conservation of cash. This rationale was evident in the case of the three local banks during the COVID-19 pandemic when the Monetary Authority of Singapore (MAS) recommended local banks to curtail their dividend payments and offer scrip dividends as an option. This preemptive measure aimed to address potential uncertainties caused by the COVID-19 pandemic.
By choosing to issue additional shares instead of disbursing cash dividends, companies can bolster their cash reserves, ensuring they have sufficient liquidity for operational contingencies, investments, debt management, and strategic endeavors.
This strategic use of scrip dividends becomes particularly relevant during periods characterized by economic turbulence or when companies prioritize preserving their financial resources, as in the case of our local banks during the pandemic.
Apart from cash conservation, the issuance of scrip dividends aligns with broader goals such as:
- Enhancing Shareholder Engagement: Offering scrip dividends is an effective way to cultivate shareholder engagement. By allowing us to acquire additional shares, companies encourage us to maintain a vested interest in the company’s long-term success.
- Strategic Capital Management: Scrip dividends also allow companies to manage their capital structure more dynamically. This approach can play a pivotal role in optimizing the company’s financial health, capitalizing on growth opportunities, and maintaining an appropriate balance between equity and debt.
- Signaling Confidence: Lastly, opting for scrip dividends could also signal the company’s confidence in its future prospects. It may be an indication that the company views the reinvestment of funds into the business as a more promising avenue than immediate cash disbursement.
All in all while the specific reasons may vary from one company to another, the central theme revolves around striking a strategic balance between preserving cash and supporting sustainable growth.
The decision between Cash or Scrip Dividend: What to Choose?
Now, the question arises: should you opt for cash or scrip dividend?
Well, the answer is contingent on a few factors.
Firstly, it’s important to note that companies don’t always provide the option of a scrip dividend, which means the choice might not always be available to you.
However, if the option is indeed presented, here are the reasons to consider.
3 Reasons to choose Scrip Dividend
1) Potential Capital Appreciation
An intriguing facet of scrip dividends lies in the potential for capital appreciation. When a company announces the issue price for the new shares to be allotted to shareholders, it often sets it based on the average historical price. Consequently, during this interim period, you may find yourself with a unique opportunity to acquire shares of a company at a more favorable price than the prevailing market rate.
Consider the case of DBS’s scrip dividend as an illustration. When the company unveiled its scrip dividend with new shares to be issued at $23.93 per share on 16th November 2020, by the time investors must decide whether or not to partake on 9th December 2020, the share price had already appreciated by 2.8% to $24.60. This effectively translated to a 2.8% ‘increase’ in the value of the dividend for investors that picked the Scrip dividend since you are acquiring shares at $23.93 each instead of the market rate of $24.60.
Of course, this can go the other way where the stock price drops, but then you can still take cash dividends so you do not lose out.
2) Automatic reinvestment
Scrip dividends also offer a convenient gateway to automatic reinvestment, an approach that aligns with the principles of effortless wealth accumulation. By choosing the scrip dividend option, you can seamlessly channel dividends back into the company.
This mechanism is excellent in generating a compounding effect that amplifies our ownership stake over time. The beauty of this approach lies in its simplicity: the intricate process of manual reinvestment is rendered obsolete. No more additional transaction fees and brokerage charges that typically accompany manual reinvestment.
3) Tax Deferral
While tax considerations might not apply to Singapore stocks due to the absence of dividend tax, scrip dividends offer a unique tax deferral advantage in certain countries.
By reinvesting dividends rather than receiving them as immediate cash, we can potentially defer our tax liability. This deferral persists until the newly acquired shares are eventually sold.
3 Reasons to choose Cash Dividends instead
That said, while the allure of scrip dividends is evident, there are compelling reasons to opt for a cash dividend too.
1) Odd Lots Dilemma
The thing is, scrip dividends often come in irregular amounts, known as odd lots. Unless you’re extremely lucky, having a smaller number of shares will likely land you with odd lots.
Take the DBS example mentioned earlier. If you only held 500 shares and the company offered a $0.18 dividend per share, you’d end up with about $90 worth of stocks – that’s roughly 4 DBS shares ($90 ÷ $23.93/share, rounded to the nearest whole number).
Now, 4 shares might seem odd (pun intended). Since standard trading lots are usually 100 for SGX stocks, selling these odd lots might be a bit tricky. This could make it difficult to cash out your dividend effectively.
The good news is that things are getting better. Some brokers are letting us to directly access the SGX Unit Share market from their online trading platforms. However, keep in mind that processing odd lot share orders might take longer due to lower trading volume.
2) Cash is king
It’s also understandable that some of us rely on dividends for our retirement cash. Opting for cash dividends offers flexibility. It lets us decide where to use the money. Whether it’s paying bills, making investments, or diversifying our portfolio, cash dividends allow us to handle our finances based on our personal situations.
3) Reducing Risks
Lastly, many companies offer scrip dividends primarily to save cash. By digging into why they’re doing this, we can get a good sense of the company’s financial health and whether our investment is still sound.
If there’s uncertainty about the company’s future, going for cash dividends can be a wise choice. It helps prevent further risk if the company’s situation is shaky.
Conclusion
In conclusion, deciding between cash dividends and scrip dividends is not a one-size-fits-all choice. While the appeal of scrip dividends is clear, offering the potential for increased shares and capital appreciation, there are noteworthy advantages to favoring cash dividends.
The challenges associated with odd lots can make handling scrip dividends less convenient, particularly for those with smaller shareholdings. On the other hand, cash dividends offer immediate liquidity, granting investors the freedom to allocate funds as needed – for daily expenses, investments, or portfolio diversification.
Moreover, the careful consideration of a company’s motivation for offering scrip dividends reveals essential insights into its financial health and long-term prospects. In situations where uncertainty clouds the horizon, the prudence of opting for cash dividends becomes evident, as it prevents further exposure to potential risks.
Ultimately, the choice hinges on individual financial goals, circumstances, and the investor’s comfort level with the company’s trajectory. By weighing these factors thoughtfully, investors can make an informed decision that aligns with their needs and aspirations, ensuring a balanced approach to wealth management and investment strategies.
p.s. if you’re looking to build a dividend portfolio that could replace the income from your full time job, Chris shares how he did it.
Awesome article, thanks. I think cash option would be better. I get the cash option now and use it to buy different dividend stocks. Sometimes I’ll reinvest in the same stock that paid me but it is nice to have the option to spread it around when you want to. I am going for a dividend investing strategy for my retirement along with my 401k so this works better for me. Again, awesome article.