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. Are stock dividends and stock splits taxed?

    Understand different tax implications for dividend payments and stock splits; main factors include the type of account and ... Read Answer >>
  4. What is a dividend?

    When a company makes a profit and decides not to reinvest the profit in the business, it can pay out a portion to each of ... Read Answer >>
  5. How do dividends affect the balance sheet?

    Learn how different types of dividends, such as cash dividends and stock dividends, affect a company's balance sheet, based ... Read Answer >>
  6. Why would a company choose to pay a stock dividend instead of a cash dividend?

    Find out why a company might choose to divide its profit in the form of a stock dividend instead of a cash dividend and how ... Read Answer >>
Related Articles
  1. Investing Basics

    What Are Corporate Actions?

    Corporate actions are processes that change a company’s stock. Here are a few examples.
  2. Investing Basics

    Dividend Facts You May Not Know

    Discover the issues that complicate these payouts for investors.
  3. 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.
  4. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  5. Markets

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  6. Investing Basics

    Don't Take Dividends For Granted

    Companies have been paying dividends to their shareholders since the 1600s and have given investors good reason to hold onto their shares for long time periods. For many investors, dividends ...
  7. Active Trading

    Don't Let Stock Prices Fool You

    Find out why a stock with a six-figure share price can still be a good value.
  8. Stock Analysis

    If You Had Invested Right After JPMorgan's IPO (JPM)

    Find out how much your investment would be worth in 2016 if you had purchased 100 shares during JPMorgan's IPO, including the impact of dividends and splits.
  9. Investing

    Dividend Yield For The Downturn

    High-dividend stocks make excellent bear market investments, but the payouts aren't a sure thing.
  10. Stock Analysis

    The Top 5 Dividend Paying Oil Stocks for 2016

    Discover the top five dividend-paying oil companies for 2016 and what factors contribute to their ability to continue dividend payments.
RELATED TERMS
  1. Dividend

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

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

    A corporate action in which a company divides its existing shares ...
  4. Outstanding Shares

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

    The dividend yield that a share of stock would return based on ...
  6. Property Dividend

    An alternative to cash or stock dividends. A property dividend ...
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center