Advanced Diploma of Financial Planning (ADFP) Practice Test

Which characteristic of common stocks involves receiving dividends in the form of additional shares?

1. Stock buyback

2. Stock dividend

3. Cash dividend

4. Preferred dividend

The correct answer is: Stock dividend

The characteristic of common stocks that involves receiving dividends in the form of additional shares is known as a stock dividend. This process allows companies to reward shareholders by issuing additional shares rather than cash. When a stock dividend is declared, shareholders receive a certain percentage of additional shares based on their current holdings. For example, if a company declares a 10% stock dividend, a shareholder who owns 100 shares will receive an additional 10 shares. This approach can enhance liquidity and allow shareholders to benefit from the compounding effect of owning more shares over time, without the company needing to use its cash reserves. In contrast, stock buybacks involve a company repurchasing its own shares from the market, which can reduce the number of outstanding shares and potentially increase the value of remaining shares. Cash dividends involve direct payments to shareholders, which do not add to the number of shares held. Preferred dividends pertain specifically to preferred stocks, which have different rights and characteristics compared to common stocks. Therefore, stock dividend is the correct term for this action relating to common stocks.