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?

  1. Do mutual funds pay interest?

    Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
  2. Do dividends affect working capital?

    Regardless of whether cash dividends are paid or accrued, a company's working capital is reduced. When cash dividends are ... Read Full Answer >>
  3. Do mutual funds pay dividends?

    Depending on the specific assets in its portfolio, a mutual fund may generate income for shareholders in the form of capital ... Read Full Answer >>
  4. How often do mutual funds pay capital gains?

    The frequency with which mutual funds pay capital gains varies. However, funds that generate a profit within a given year ... Read Full Answer >>
  5. Can dividends be paid out monthly?

    Though it is more common for dividends to be paid quarterly or annually, some stocks do pay monthly dividends. Dividends: ... Read Full Answer >>
  6. Are dividends considered an asset?

    Whether dividends paid on stock are considered an asset depends on which role you play in the investment: the issuing company ... Read Full Answer >>
Related Articles
  1. Stock Analysis

    The 4 Best Buy-and-Hold Dividend Stocks

    Discover four of the best dividend stocks for investors to buy and hold, along with the reasons for each stocks' suitability for long-term success.
  2. Stock Analysis

    8 Solid Utility Stocks for a Bear Market

    If you're seeking modest appreciation, generous dividend payments and resiliency, consider these eight utility stocks.
  3. Investing Basics

    4 Reasons a Company Might Suspend Its Dividend

    Learn about the four most common reasons a company may choose to suspends its dividends, including financial trouble, funding growth and unexpected expenses.
  4. Mutual Funds & ETFs

    Top 4 Conservative Allocation Mutual Funds

    Discover the top-rated mutual funds in the conservative allocation category, and learn which investors can utilize them most effectively.
  5. Stock Analysis

    This is What Bill Gates's Portfolio Looks Like

    Find out about the stocks Bill Gates has in his portfolio. Learn about the close personal and business relationship Gates has with Warren Buffett.
  6. Savings

    7 Millionaire Myths

    Here are seven millionaire myths and realities that reveal they don’t quite have it all.
  7. Investing Basics

    5 Common Misconceptions About Dividends

    Here are five common misconceptions about dividends that are important to know.
  8. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  9. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  10. Stock Analysis

    Is BP's High-Yield Dividend Safe?

    Learn how receiving a greater than 7% yield from an oil major is a rare opportunity and one that comes with a fair share of potential dangers.
  1. Record Date

    The cut-off date established by a company in order to determine ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through ...
  3. Profit Margin

    Profit margin is part of a category of profitability ratios calculated ...
  4. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
  5. Dividend

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

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

You May Also Like

Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
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!