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. Which is better a cash dividend or a stock dividend?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two main types of dividends: ... Read Answer >>
  2. How does a stock split affect cash dividends?

    When a company decides to issue a stock split (or stock dividend), a couple of possibilities could occur concerning what ... Read Answer >>
  3. Can dividends be paid out monthly?

    Find out if stocks can pay dividends monthly, and learn about the types of companies most likely to do so and how monthly ... Read Answer >>
  4. Are dividends considered an asset?

    Find out why dividends are considered an asset for investors but a liability for the company that issued the stock, and learn ... Read Answer >>
  5. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Answer >>
  6. How do dividends affect retained earnings?

    Find out how distribution of dividends affects a company's retained earnings, including the difference between cash dividends ... Read Answer >>
Related Articles
  1. Professionals

    Accounting for Dividends

    CFA Level 1 - Accounting for Dividends. Learn the types, terminology and how to account for dividends. See how stock splits and issuance rules affect corporate dividend policy.
  2. Professionals

    Dividends and Stock Splits

    Series 7 - Equities Section 3: Dividends and Stock Splits
  3. Professionals

    Dilutive Effect of Splits and Dividends

    CFA Level 1 - Dilutive Effect of Splits and Dividends. This section highlights the dilutive effects of stock splits and dividends. Provides an example showing how splits and dividends affect ...
  4. Investing Basics

    What Are Corporate Actions?

    Corporate actions are processes that change a company’s stock. Here are a few examples.
  5. Professionals

    Stock Dividends And Stock Splits

    Stock dividends and stock splits also have effects on a company's stock price.
  6. Bonds & Fixed Income

    What Are Corporate Actions?

    Be a savvy investor - learn how corporate actions affect you as a shareholder.
  7. Investing Basics

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  8. Investing Basics

    Stock Splits: A Closer Look At Its Effects

    Most trades, including short sales and options, aren't materially affected by a stock split. Still, it's important for shareholders to understand how these events impact various aspects of investing. ...
  9. Investing Basics

    Reinvesting Dividends Pays in the Long Run

    Find out why dividend reinvestment is one of the easiest ways to grow wealth, including how this tactic can increase your investment income over time.
  10. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
RELATED TERMS
  1. Cash-And-Stock Dividend

    A corporation distributing earnings to its shareholders as both ...
  2. Dividend

    A distribution of a portion of a company's earnings, decided ...
  3. Accumulating Shares

    Common stock given to current shareholders of a company in place ...
  4. Stock Split

    A corporate action in which a company divides its existing shares ...
  5. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  6. Outstanding Shares

    A company's stock currently held by all its shareholders, including ...

You May Also Like

Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center