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Dividends > Cash Dividend Alternatives
Cash Dividend Alternatives
• Stock Splits
• Stock Dividends
• Reverse Splits
• Share Repurchases
• Benefits of Share Repurchases
• Drawbacks of Share Repurchases
• Dividend Reinvestments
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Dividends > Cash Dividend Alternatives
Stock Splits
• A stock split is executed by offering several new shares in exchange for old
ones.This may be a 3-for-1 split, for example: each share could be traded in for
three new ones.
• A stock split does not change the market capitalization of the firm, it merely
changes the number of shares outstanding.Therefore the price per share
decreases as the number of shares outstanding increases.
• Each shareholder retains his or her same ownership stake because the number of
share s/he holds changes in proportion to the change in the total number of
shares outstanding.
Berkshire Hathaway
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Dividends > Cash Dividend Alternatives
Stock Dividends
• Stock dividends are no different than stock splits in practice.They simply increase
the number of shares outstanding, but not the market capitalization or the total
value of the shareholders' assets.
• Stock dividends may be paid from non-outstanding stock or from the stock of
another company (e.g. its subsidiary).
• Cash dividends are taxed while stock dividends are not.
• The journal entry to record the stock dividend is a debit to the retained earnings
account and credit both common stock and the paid in capital accounts.
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Dividends > Cash Dividend Alternatives
Reverse Splits
• In a reverse stock split (also called a stock merge), the company issues a smaller
number of new shares.New shares are typically issued in a simple ratio, e.g. 1
new share for 2 old shares, 3 for 4, etc.
• A reverse split boosts the share price, so there is a stigma attached.Some
investors have rules against trading shares below a certain value, so a company
in financial trouble may issue a reverse split to keep their share price above that
threshold.
• A reverse stock split may be used to reduce the number of shareholders.If a
company completes reverse split in which 1 new share is issued for every 100 old
shares, any investor holding less than 100 shares would simply receive a cash
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Dividends > Cash Dividend Alternatives
Share Repurchases
• Since the market capitalization is unchanged and the number of shares
outstanding drops, a share repurchase will lead to a corresponding increase in
stock price.
• The reduction of the shares outstanding means that even if profits remain the
same, the earnings per share increase.
• There are a number of methods for repurchasing shares, the most popular of
which is open-market: the company buys back shares at the market dictated price
if the price is favorable.
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Dividends > Cash Dividend Alternatives
Benefits of Share Repurchases
• If management feels the company is undervalued, they will repurchase the stock,
and then resell it once the price of the shares increases to reflect the accurate
value of the firm.
• A member of management may have to meet earnings per share (EPS) metrics
which can be increased by increasing earnings or lowering the number of
outstanding shares.Share repurchases decrease the number of outstanding
shares, and thus increase EPS.
• To prevent a firm from acquiring enough of a company's stock to take it over, the
takeover target may buy back shares, often at a price above market value.
Marc Benioff
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Dividends > Cash Dividend Alternatives
Drawbacks of Share Repurchases
• Insiders are more likely to know if a firm is undervalued, and are therefore more
likely to know whether they should sell their shares in an open-market
repurchase.
• Financial ratios that use the number of shares outstanding change when shares
are repurchased.Executives and management whose compensation is tied to
these metrics have an incentive to manipulate them through share repurchases.
• Share repurchases are often not completed.It is tough to value the effect of a
share repurchase announcement because it is unknown whether it will occur in
full.
Martha Stewart
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Dividends > Cash Dividend Alternatives
Dividend Reinvestments
• DRIPs help shareholders reinvest their dividends in the underlying stock without
having to wait for enough money to buy a whole number of shares.It also may
allow them to avoid some brokerage fees.
• DRIPs help stabilize stock prices by inherently encouraging long-term investment
instead of active-management, which may cause volatility.
• DRIPs are generally associated with programs offered by the company.However,
brokerage firms may offer similar reinvestment programs called "synthetic
DRIPs".
Charles Schwab
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Appendix
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Dividends
Key terms
• Earnings Per Share EPS.(Net Income - Dividends on Preferred Stock) / Outstanding Shares
• Earnings Per Share The amount of earnings per each outstanding share of a company's stock.
• hostile takeover An attempted takeover of a company that is strongly resisted by the target company's management.
• insider A person who has special knowledge about the inner workings of a group, organization, or institution.
• market capitalization The total market value of the equity in a publicly traded entity.
• outstanding shares Shares outstanding are all the shares of a corporation that have been authorized, issued and purchased by
investors and are held by them.
• outstanding stock all the stock of a corporation or financial asset that have been authorized, issued and purchased by investors
and are held by them
• reinvest To invest cash again, instead of holding it as cash.
• Repurchase To buy back a company's own shares.The issuing company pays public shareholder for their shares.
• stock dividend a payment to a shareholder paid out in the form of additional stock shares of the issuing corporation, or another
corporation (such as its subsidiary corporation)
• stock split To issue a higher number of new shares to replace old shares.This effectively increases the number of shares
outstanding without changing the market capitalization of the company.
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Dividends
Berkshire Hathaway
Berkshire Hathaway has famously never had a stock split, and has never paid a dividend.As a result its Class A shares traded at $121,775.00 as of May
2, 2012, making them the highest-priced shares on the New York Stock Exchange.
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Dividends
Charles Schwab
Brokerage firms like Charles Schwab earn money by charging a brokerage fee for executing transactions.Thus, participating in a DRIP helps
shareholders avoid some or all of the fees they would occur if they reinvested the dividends themselves.
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Dividends
Martha Stewart
Martha Stewart was convicted of insider trading, which is not the same as insiders choosing whether to sell their shares in a share repurchase.Insiders
are still at an advantage because they will know not to sell during the share repurchase.
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Dividends
SEC
The Securities and Exchange Commission is the department that sets the different regulations regarding stock trading and splitting.
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Dividends
Marc Benioff
CEOs, like Marc Benioff of Salesforce.com, may have to meet certain financial targets in order to earn his or her bonus.If one of these targets is EPS,
they may have an incentive to try to increase EPS artificially.
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Dividends
Supreme Court Seal
The Eisner vs. Macomber case was a US Supreme Court Case that helped determine the differences in taxation of cash and stock dividends.
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Dividends
Which of the following changes after a stock splits?
A) The stock's per share price.
B) The company's total market value.
C) The stockholder's ownership percentage in the company.
D) All of these answers.
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Dividends
Which of the following changes after a stock splits?
A) The stock's per share price.
B) The company's total market value.
C) The stockholder's ownership percentage in the company.
D) All of these answers.
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Dividends
Which of the following accurately describes how a stock dividend
differs from a stock split?
A) A stock dividend is paid using already issued shares; a split requires
new shares to be issued.
B) A stock dividend causes the stock's price to fall; a stock split does not.
C) A stock dividend increases the shareholder's percentage ownership in
the company; a split does not.
D) All of these answers.
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Dividends
Which of the following accurately describes how a stock dividend
differs from a stock split?
A) A stock dividend is paid using already issued shares; a split requires
new shares to be issued.
B) A stock dividend causes the stock's price to fall; a stock split does not.
C) A stock dividend increases the shareholder's percentage ownership in
the company; a split does not.
D) All of these answers.
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Dividends
The following journal entry would account for which of the
following transactions? Dr. Retained earnings Cr. Common stock
Cr. Paid-in capital
A) paid-in capital
B) stock dividends
C) cash dividends
D) stock split
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Dividends
The following journal entry would account for which of the
following transactions? Dr. Retained earnings Cr. Common stock
Cr. Paid-in capital
A) paid-in capital
B) stock dividends
C) cash dividends
D) stock split
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Dividends
Which of the following is a reason a company might have for
initiating a reverse stock split?
A) To decrease the number of its shareholders.
B) To prevent the stock from being delisted from a stock exchange.
C) All of these answers.
D) To encourage institutional investors and mutual funds to purchase the
stock.
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Dividends
Which of the following is a reason a company might have for
initiating a reverse stock split?
A) To decrease the number of its shareholders.
B) To prevent the stock from being delisted from a stock exchange.
C) All of these answers.
D) To encourage institutional investors and mutual funds to purchase the
stock.
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Dividends
Which of the following repurchasing method definitions is NOT
correct?
A) Repurchase Put Rights: The firm announces that it will repurchase a
number of shares at a set price.
B) Open Market: The firm buys its stock on the open market from
shareholders.
C) Selective Buy-Backs: The firm makes repurchase offers privately to
some shareholders.
D) Employee Share Scheme Buy-Back: The company repurchases
shares held by employees.
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Dividends
Which of the following repurchasing method definitions is NOT
correct?
A) Repurchase Put Rights: The firm announces that it will repurchase a
number of shares at a set price.
B) Open Market: The firm buys its stock on the open market from
shareholders.
C) Selective Buy-Backs: The firm makes repurchase offers privately to
some shareholders.
D) Employee Share Scheme Buy-Back: The company repurchases
shares held by employees.
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Dividends
Which of the following is a benefit shareholders can obtain by
repurchasing its shares?
A) Shareholders have a higher percent ownership in the company at a
higher per share price.
B) Share repurchases can boost EPS, which can in turn increase
management compensation.
C) Share repurchases can deter hostile takeovers.
D) All of these answers.
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Dividends
Which of the following is a benefit shareholders can obtain by
repurchasing its shares?
A) Shareholders have a higher percent ownership in the company at a
higher per share price.
B) Share repurchases can boost EPS, which can in turn increase
management compensation.
C) Share repurchases can deter hostile takeovers.
D) All of these answers.
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Dividends
Which of the following is a drawback of share repurchases for
shareholders?
A) Share repurchases can be used to manipulate financial metrics, which
can mislead investors.
B) All of these answers.
C) Shareholders can have a hard time gauging how a repurchase will
affect the value of their holdings.
D) Insiders have an advantage of knowing when to sell, which puts other
shareholders at a disadvantage.
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Dividends
Which of the following is a drawback of share repurchases for
shareholders?
A) Share repurchases can be used to manipulate financial metrics, which
can mislead investors.
B) All of these answers.
C) Shareholders can have a hard time gauging how a repurchase will
affect the value of their holdings.
D) Insiders have an advantage of knowing when to sell, which puts other
shareholders at a disadvantage.
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Dividends
Which of the following is a shareholder benefit associated with a
dividend reinvestment program (DRIP)?
A) DRIPs help to stabilize the stock price.
B) All of these answers.
C) DRIPs allow the investors to reinvest their dividend income in the
company quickly.
D) DRIPs allow investors take advantage of dollar-cost averaging.
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Dividends
Which of the following is a shareholder benefit associated with a
dividend reinvestment program (DRIP)?
A) DRIPs help to stabilize the stock price.
B) All of these answers.
C) DRIPs allow the investors to reinvest their dividend income in the
company quickly.
D) DRIPs allow investors take advantage of dollar-cost averaging.
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Dividends
Attribution
• Wikipedia. "Berkshire Hathaway." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Berkshire_Hathaway
• Wikipedia. "Stock split." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Stock_split
• Wiktionary. "market capitalization." CC BY-SA 3.0 http://en.wiktionary.org/wiki/market+capitalization
• Wikipedia. "Dividend." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend
• Wikipedia. "Dividend reinvestment plan." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend_reinvestment_plan
• Wikipedia. "Retained earnings." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Retained_earnings
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/reinvest
• Wikipedia. "Share repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Share_repurchase
• Wikipedia. "Accelerated Share Repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Accelerated_Share_Repurchase
• Wikipedia. "Targeted repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Targeted_repurchase
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/earnings-per-share
• Wiktionary. "insider." CC BY-SA 3.0 http://en.wiktionary.org/wiki/insider
• Wikipedia. "outstanding shares." CC BY-SA 3.0 http://en.wikipedia.org/wiki/outstanding%20shares
• Wikipedia. "Reverse stock split." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Reverse_stock_split
• Wikipedia. "Outstanding stock." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Outstanding_stock
• Wikipedia. "Share repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Share_repurchase
• Wikipedia. "Targeted repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Targeted_repurchase
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Dividends
• Wikipedia. "Accelerated share repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Accelerated_share_repurchase
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/earnings-per-share
• Wiktionary. "hostile takeover." CC BY-SA 3.0 http://en.wiktionary.org/wiki/hostile+takeover
• Wikipedia. "Eisner v. Macomber." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Eisner_v._Macomber
• Wikipedia. "Eisner v. Macomber." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Eisner_v._Macomber
• Wikipedia. "Stock dividend." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Stock_dividend
• Wikipedia. "Stock dividend." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Stock_dividend#Forms_of_payment
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/stock-split
• Wikipedia. "Share repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Share_repurchase
• Wikipedia. "Accelerated share repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Accelerated_share_repurchase
• Wikipedia. "Targeted repurchase." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Targeted_repurchase
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/repurchase
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