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Over the last 25 years of the 20th century, cash dividends declined as a percentage of earnings, but companies paying higher cash dividends have generally experienced higher returns during periods of market downturn. Dividends cushion the stock price fall and normally prop up share returns as long as the dividend can be sustained. However, there have been many cases of cuts in cash dividends. So the purchase of equity shares simply because of a current high dividend yield (dividends/stock price) cannot assure success. Accordingly, the ability of a company to maintain, or possibly increase, its cash dividend is an important aspect of share valuation for stocks with a high dividend yield. The best way to understand the ability of a company to continue paying its current dividend is by looking at the firm’s cash flow, not necessarily the income statement or the balance sheet.

A common fallacy with respect to dividends paid in a company’s stock (stock dividends or stock splits) is that investors get something of value as the result of the share distribution. Uninitiated investors normally like receiving such share distributions. They often feel a stock is cheaper if it’s at 20 as opposed to 40. This is silly in that if a company has 200 shares outstanding at a price of $20, it is quite the same thing as having 100 shares outstanding at a price of $40. In both cases the total capitalization (shares outstanding multiplied by their market price) of the firm is $4,000. All it has accomplished as the result of a two-for-one stock split or a 100 percent stock dividend is to double the number of shares outstanding with an almost certain halving of their market price. Stockholders have more pieces of paper as the result of a share distribution, but no increase in total value. So stock dividends and stock splits, when unaccompanied by increases in earnings or cash dividends, do not really mean a thing.

With electronic recording of share ownership, having more pieces of paper is not of great consequence. However, in terms of transaction costs, when investors seek to sell their shares, the cost of exiting their position will generally be greater if a larger number of shares are sold. This is particularly the case for institutional investors such as mutual funds that pay their commissions on the basis of pennies per share. The greater the number of shares such investors sell, the more the trade will cost.

Also of consequence in this respect is the bid-ask spread, which is the difference between what an investor can sell his or her shares for at any particular time versus the price the investor must pay if the shares are bought at that precise time. (Bid-ask spreads are more commonly known as the price a dealer will pay for a security – the bid price – versus what the dealer will sell the security for – the ask price). Accordingly, other things being equal, in terms of the total cost of the bid-ask spread, the greater the number of shares involved in any particular transaction, the larger the cost to the investor. In essence, the bid-ask spread is also a form of transaction cost in addition to commissions and must be considered in determining the cost of entering and exiting a position in stock. If an investor has more shares as the result of a share distribution, his or her transaction costs will, other things being equal, be greater. In this sense, contrary to popular belief, share distributions provide negative value to investors.