A:

Every corporation has the same goal in mind: to maximize shareholder wealth. This goal is fulfilled in two different ways, by re-investing cash into the business to stimulate its growth, or by paying dividends to shareholders. A dividend can take the form of either cash or stock. In the case of a cash dividend, a shareholder will receive cash based on the the number of shares they own. Let's say a corporation declares a cash dividend of $0.25 per share, if an investor owns 10,000 shares, then this investor would receive $2,500.

If, on the other hand, an investor still owns the same 10,000 shares, but the company declares a stock dividend of 0.2, this would mean that for every share owned, 0.2 of a share (called a fractional share) is "paid" to the shareholder. So, for our investor with 10,000 shares, after the dividend was collected they would own 12,000 shares (10,000 x 1.2). The effect of this stock dividend on the stock price, however, may not be as positive. The stock dividend, and a stock split, will increase the number of shares outstanding, and with all other things remaining the same, the stock price will fall. Therefore, the stock price would dilute from either a stock dividend or a stock split.

Stock prices are based on the value of the firm divided by the number of shares outstanding. If the number of shares outstanding increases, the stock price will fall. For example, say there is a firm with a market cap of $750 million, and there are 200 million shares outstanding at the stock price of $3.75 ($750/200). If there is a stock dividend declared of 0.2, then the number of shares outstanding will increase by 20% to 240 million. With this new number of shares outstanding, and the company's market cap remains the same, but the share price will now decrease to $3.13 ($750/240). Conversely, the same results would occur if the firm decided to split the stock 6:5, which means that for every 5 shares currently owned, the shareholders will receive a total of 6 stocks after the split. The number of shares outstanding would increase to 240 million (200 x 1.2), and the market price would be diluted to $3.13.

One positive characteristic of the stock dividend and stock split, is that ownership is not further diluted. That is to say, all shareholders will own the same proportionate amount of the company after the dividend or split as they did before.

If you are interested in learning more about dividends, read The Importance Of Dividends article, or How and Why Do Companies Pay Dividends?

RELATED FAQS

  1. How can the price of a stock change on the ex-dividend date?

    Find out more about dividend-paying stocks and how the prices of dividend-paying stocks are affected on the ex-dividend date, ...
  2. How is the ex-dividend date for a dividend on a stock determined?

    Review the important dates concerning dividend payments and learn how the ex-dividend date is determined when a company declares ...
  3. What are the drawbacks of a small investor buying blue-chip stocks?

    Understand what a blue-chip stock is and learn about the drawbacks a small investor might face when investing in blue-chip ...
  4. What is the average annual dividend yield of companies in the automotive sector?

    Learn about the average trailing annual dividend yield for companies in the automotive sector and what the dividend yield ...
RELATED TERMS
  1. Record Date

    The cut-off date established by a company in order to determine ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Target Payout Ratio

    A target payout ratio is a measure of what size a company's dividends ...
  4. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. S&P 500 Dividend Aristocrats

    Companies that have had an increase in dividends for 25 consecutive ...

You May Also Like

Related Articles
  1. Stock Analysis

    Why Hasn't McDonald's Beaten The Dow ...

  2. Investing Basics

    Four Buy and Hold Stocks for Millennials

  3. Mutual Funds & ETFs

    ETF Dividends: The Lowdown on How They're ...

  4. Stock Analysis

    Microsoft Is Paying Dividends. Is Its ...

  5. Fundamental Analysis

    How Private Equity Dividends Work

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!