Determined to build a dividend-focused portfolio, you research spin-off stocks and identify a candidate with growth potential. But does the stock fit your portfolio profile, is a spinoff considered a dividend? Keep reading, the answer will surprise you.
Is a Spinoff considered a Dividend?
A spinoff is not considered a dividend because a spinoff is a corporate action of separating or divesting a company subsidiary to form an independent entity, while a dividend is a payment, either in cash or stock, to shareholders of an existing firm.
To answer the question: Is a spinoff considered a dividend? The fact that a spinoff and dividends are different ways of returning value to shareholders must be considered. Here’s how it works:
Distribution Difference – When a division is separated from the parent firm to form a spinoff, shares in the new entity are distributed to the existing parent company shareholders on a pro-rata basis. These shareholders receive ownership shares in the newly formed spinoff, not a cash payment.
A dividend is a periodic cash payment made from the retained earnings or profits of an existing company to its current shareholders. There is no ownership transfer associated with dividend distributions.
Source of Value – Is a spinoff considered a dividend? The source of value is a key differentiator between the two. The spinoff value received by the parent company shareholders is derived from the fixed and intangible assets and operations of the spinoff and not from the parent company earnings.
The value received from dividend distributions is a portion of a firm’s earnings. The percentage of net income paid to shareholders as dividends is called the dividend payout.
Investor Portfolio Impact – Spinoffs and dividends have different investor portfolio impacts. Spinoff share value can oscillate over time during various market cycles. They possess specific growth potential and are subject to systematic and idiosyncratic risk exposure.
Dividends provide an investor with immediate portfolio cash flow which can be deployed into other investment opportunities or used for personal pursuits.
Spinoffs and dividends can create value; however, execution methods, time horizons, and portfolio implications differ. Dividends can be viewed as more valuable in terms of the time value of money, whereas the potential capital appreciation, possible future dividends, and subsequent capital gains of a new spinoff are yet to be realized.
Taxable Event – A spinoff transaction can be structured to render favorable tax treatment for the parent and spinoff companies, provided certain conditions are met. Dividend distribution tax treatment is jurisdiction-dependent and may or may not trigger a taxable event. Receiving distributions within a Roth IRA are usually tax-free. Consulting a tax professional is prudent investing.
Is a spinoff considered a dividend? Spinoffs and dividends are shareholder distributions capable of value creation but with different mechanics, investor portfolio impacts, and tax implications. A spinoff is not considered a dividend based on these differing characteristics.
Read next: What Is the Holding Period for a Spin-Off?
