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?


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