Why might a stock dividend or a stock split be of limited value to an investor?
Why might a stock dividend or a stock split be of limited value to an investor?A stock dividend is a distribution made by a firm to its shareholders in the form of additional shares. Oftentimes, a firm opts to pay a stock dividend (rather than a cash dividend) to preserve cash for business needs. This type of dividend provides limited benefit to an investor who desires income/cash or wishes to limit the size of his ownership position. However, it provides some tax advantage, as it is generally not taxable upon receipt.A stock split differs from a stock dividend. A split is a corporate action which divides a firm's outstanding shares into additional shares, while proportionally reducing the market value of each share. This transaction offers no economic value to shareholders, but the smaller per share value makes future investment feasible for a broader group of market participants.What about a stock repurchase?A stock repurchase is a financial transaction, whereby the firm buys back its shares. From an investor's perspective, this can be preferable to a cash dividend, because the capital gains tax on a buyback is lower than the ordinary income tax on a dividend payment.Does it make sense for a corporation to repurchase its own stock?The motivations for a stock repurchase can vary. Generally, management will initiate a buyback when it believes the firm's shares are undervalued and/or the market is exhibiting sustained upward momentum. Another reason management could look to initiate a buyback is to effect an increase in earnings per share (EPS), a closely watched performance metric. By reducing the number of shares outstanding, a firm's earnings are spread across a smaller number of shares, which drives the EPS figure upward. This type of financial engineering doesn't generate any real value, but surprisingly, it can have a favorable impact on the stock's valuation.
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