Wednesday, December 13, 2017

Stock Dividends - The Gift of Nothing

Have you ever been tempted to wrap up an empty box and give it to your spouse for your anniversary. You could say something mushy like, "this isn't an empty box, it is filled with all my love." I don't know how your spouse would react, mine would see through this ploy as me just trying to be cheap.

A stock dividend, also known as a "scrip dividend", is a dividend payment made with stock instead of cash. Sometimes when companies are tight on cash, they will declare and pay a stock dividend in lieu of a cash dividend. Most shareholders feel like they are getting something. But are they really?

In short, a stock dividend is nothing more than a glorified stock split. At the end of the process, the shareholder has more shares that are worth less. Like a stock split, you can not create value by issuing paper and getting nothing in exchange. After a stock split or stock dividend, the company has no more assets or liabilities than before the transaction, so it is not worth any more or less. There are only more shares outstanding, thus each share is now worth less. The intrinsic value of the company is unchanged.

There are some arguments for stock splits, such as liquidity (how easily a stock can be bought or sold in the market). Once a share price reaches a certain level, fewer shareholders are willing to invest in it, thus marginally lowering its liquidity. The perfect example of this is Berkshire Hathaway (BRK.A), Warren Buffett's company, trades at about $295,000 per share. Though BRK.A has an astonishing history of excellent performance, I do not own it nor am I likely to buy it at any time in the future because one share of it would be over my allocation for any individual stock. Recognizing this, but not willing to split the stock, Berkshire created a second class of stock (BRK.B) that is currently trading around $196 per share.

It is important to note that there are costs associated with stock splits and stock dividends (e.g. exchange fees, transfer agents, etc.) Stock dividends generally occur on a much smaller scale than stock splits. Normally stock dividends are in the neighborhood of 5%-10%, thus any liquidity benefit would be marginal at best. Given the real costs and marginal benefit, I personally do not see any reason to ever pay a stock dividend. Instead, I continue to prefer cash dividends.

Below are several stocks that have provided their shareholders the gift of rising cash dividend for decades:

3M Co. (MMM) provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives and other chemical additives. The company has paid a cash dividend to shareholders every year since 1916 and has increased its dividend payments for 59 consecutive years.
Yield: 2.0%

McDonald's Corporation (MCD) is the largest fast-food restaurant company in the world, with about 35,000 restaurants in 119 countries. The company has paid a cash dividend to shareholders every year since 1976 and has increased its dividend payments for 40 consecutive years.
Yield: 2.3%

The Procter & Gamble Company (PG) is a leading consumer products company that markets household and personal care products in more than 180 countries. The company has paid a cash dividend to shareholders every year since 1891 and has increased its dividend payments for 60 consecutive years.
Yield: 3.1%

The Coca-Cola Company (KO) is the world's largest soft drink company, KO also has a sizable fruit juice business. The company has paid a cash dividend to shareholders every year since 1893 and has increased its dividend payments for 55 consecutive years.
Yield: 3.2%

Christmas will be here in a couple of weeks. I'm not exactly sure what I am getting my wife this year, but I can tell you now it won't be an empty box!

Full Disclosure: Long MMM, MCD, PG, KO in my Dividend Growth Stocks Portfolio. See a list of all my Dividend Growth Portfolio holdings here.

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Tags: PG, KO, MMM, MCD,