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Dividend investing is a great way for income investors to earn steady income no matter what the market is doing. But before you go buying just any dividend stock, you'll want to know what kind of dividend it pays.
So what's the difference between cash dividends vs. stock dividends? That is what we're showing you today.
We also want to show you our top dividend stock to buy right now – it pays a 7.8% dividend yield, which is more than three times the S&P 500 average.
But first, we need to make one simple distinction: cash vs. stocks.
The Benefits of Cash Dividends vs. Stock Dividends
A cash dividend is a regular cash payment by a company to shareholders. The money that goes toward dividends is often a percentage of the company's free cash that isn't used for investment.
Sometimes a company will pay a dividend without cash on hand – which is NOT good – but we'll get to that in a moment.
Dividend-paying companies will pay shareholders cash as a percentage of the share price. The more shares you own in a dividend stock, the more you get paid.
Payments can be annually, semiannually or quarterly. Whichever the company chooses will determine the size of the dividend paid. Quarterly dividends will be smaller than semiannual dividends, for example. But they would amount to the same annual dividend set at the start of the period.
Stock dividends, on the other hand, are literally a percentage payment in the form of more company shares.
If you own 100 shares in a dividend stock and the company pays a 5% stock dividend, you end up with 105 shares.
A stock dividend can be great if you're looking to hold more stake in a company that's growing. And you're only taxed on a stock dividend if you choose to turn around and sell those extra stocks for cash.
That's one difference between cash and stock dividends – cash gets taxed.
But both forms of dividend payment can also have their downsides. This is where you'll have to look deeper into the company's priorities.
The Risks of Cash Dividends vs. Stock Dividends
An important thing to remember investing in dividend stocks: Companies are self-interested. While dividends are a great benefit to shareholders, a company pays a dividend simply to attract long-term investors.
That's why there are many companies in the market paying dividends beyond their means.
It means they'll advertise a nice dividend when they might not actually have the cash to pay it. That company would end up paying investors out of its debt.
The other thing with cash dividends is that the money set aside for investors is not going toward any future growth. It's cash just sitting there to satisfy current investors and entice new ones.
With stock dividends, the downside comes from a couple things.
Most obviously, when a company dishes out more shares, there are more shares outstanding. And this devalues that shares. Your shares will be worth less.
On the flip side, you might appreciate having more shares regardless of their price if you expect the company to grow down the road. But this can also be a negative, if you're not careful. You're taking on more shares, which means you're also taking on more risk if the company doesn't grow as expected.
Those are some of the main risks of investing in stock dividends vs. cash dividends. Keep following Money Morning to learn more about dividend stocks.
And if you're looking for one of the highest-yielding dividend stocks to buy right now, look no further: