Stock Dividend

What is a Stock Dividend?

Stock Dividend is the dividend declared from the profits of the company which is discharged by the company by issuing additional shares to the shareholders of the company rather than paying such amount in cash and generally company opts for stock dividend payout when there is a shortage of cash in the company.

In simple words, it is a form of dividend payment where the companies return a profit to their investors by giving them additional shares of the company instead of a cash dividend. This makes them own a higher number of shares in that company.

The decision to issue this dividend is made by the board of directors of that company. Many times, the decision to pay these dividends is inspired by the need to keep shareholders encouraged with their investment without paying out any actual cash. This way, the investors get a healthy return on their investments, and the company also doesn’t have to part away with any capital.

Example

In general, These are mostly issued on the basis of the percentage of existing holdings of stocks. For instance, let us assume that a company XYZ has announced to issue this dividend of 30 percent. What this implies is that each and every shareholder of that company will see their stock holdings go up by 30 percent. So, if person A earlier had 100 shares of company XYZ, his share count after receiving the dividends will be 130 in number.

Please note that this, however, will have no impact on shareholder’s wealth at the time of issuance.

Small vs. Large Stock Dividends

Depending on the percentage of shares issued to the total value of shares outstandingShares Outstanding Outstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more before dividend, this can be small or large.

When the total number of shares issued is less than twenty-five percent of the entire value of shares that were outstanding before dividend, it is called a small dividend payout. On the other hand, if the total number of shares issued is more than twenty-five percent of the entire value of shares that were outstanding before dividend, it is called a large dividend payout.

The below diagram shows how the stock dividend accounting is done when the issue is small and large.

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For eg:
Source: Stock Dividend (wallstreetmojo.com)

Example (Small Issue)

90 Degree Corp has declared and issues a 20% stock dividend. On the date of the declaration, the stock sells at $50/share. Show the accounting entriesAccounting Entries Accounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. read more

The below table shows dividend accounting in case of a small issue.

Common Stock increases by an additional 20% = $1 x 10,000 x 20% = 2000. Total Common Stock becomes 12,000
Additional paid in capitalAdditional Paid In Capital Additional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market.read more due to Stock Dividends = ($50 – $1) x 10,000 x 20% = $98,000
Retained EarningsRetained Earnings Retained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more reduces by $150,000 – $100,000 = $50,000

Example (Large Issue)

90 Degree Corp has declares and issues a 40% stock dividend. On the date of declaration, the stock sells at $50/share. Show the accounting entriesAccounting Entries Accounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. read more

Below table shows the dividend accounting in case of large issue.

The common stock increased by 40% to 14,000
There is no change in the Additional Paid-in-Capital
Retained Earnings is reduced by $4000.

Income Tax treatment for stock dividend payout

In most countries, there are no tax consequences on the investor or shareholder as a repercussion of stock dividend payout. This is unlike the cash dividend payouts made to shareholders, which are subject to taxation.

Advantages When a Company Pay Stock Dividends

From the company’s perspective, the main advantage they have with paying the dividend is saving the company’s cash position. Whenever the company doesn’t have enough cash to pay dividends to its shareholders, it can pay in terms of shares. Thus, effectively costing nothing in return to the company.
Since there aren’t any tax considerations, it is beneficial for the investors as well to receive this dividend. A cash dividendCash Dividend Cash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company. Such a dividend payment liability is then discharged by paying cash or through bank transfer.read more is instead treated as income in the year it is received.
Another advantage for the companies issuing these dividends is that they might be looking at increasing liquidity of its shares by issuing more shares. This will effectively reduce the value of shares, and hence the price.

Advantages for investors investing in dividend-paying stocks

Dividend-paying stocks form an important part of any investors’ portfolio. The simple reason for this is the effect of compounding.

Let us try to understand this with the help of an example.

Suppose an investor buys stocks of a company A. Now, he owns some percentage share of that company and has fair ownership of profits on the company. Let us also assume that this company A has a history of paying stock dividends, and the investor has also received his share of these dividends. When these dividends are reinvested back into the investor’s portfolio, it has a compounded effect on their wealth.

As many times these dividends are reinvested, the investor gets more shares in his portfolio and hence, making his percentage share of ownership goes up. This, in effect, makes his owner in the profits with a larger proportion.

Disadvantages

Sometimes this payout may give a signal of acute cash shortages or distress within the company
It can also be seen that the company is involved in more risky projects, and that can cast some doubts on management.

Conclusion

In general, a company that pays the dividend is always preferred by investors as it keeps investors excited about the return on their investments. Overall, portfolios that are focused on dividend-paying companies are able to provide a sufficient source of income to its investors. Dividend-paying stocks and companies are looked upon as the most reliable and sound investment opportunities.

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Stock Dividend