Table of Contents

Stock Dividend: Pros, Cons, and How It Works

By

James Chen

Updated September 06, 2022

Reviewed by

Gordon Scott

Fact checked by

Pete Rathburn

What Is a Stock Dividend?

A stock dividend is a dividend payment to shareholders that is made in shares instead of cash. The stock dividend has the advantage of rewarding shareholders without reducing the company's cash balance.

These stock distributions are generally made as fractions paid per existing share. If a company issues a stock dividend of 5%, it is required to provide 0.05 shares for every share owned by existing shareholders. The owner of 100 shares would gain five additional shares.

Key Takeaways

A stock dividend is a dividend paid to shareholders in the form of additional shares in the company.
Stock dividends are not taxed until the shares granted are sold by their owner.
Like stock splits, stock dividends dilute the share price, but as with cash dividends, they also do not affect the value of the company.

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What Is A Dividend?

How a Stock Dividend Works

Also known as a "scrip dividend," a stock dividend is a distribution of shares to existing shareholders instead of a cash dividend. This type of dividend may be made when a company wants to reward its investors but doesn't have spare cash or chooses to preserve cash for other investments.

Stock dividends have a tax advantage for the investor. The share dividend, like any stock share, is not taxed until the investor sells it.

A stock dividend may require that the newly received shares not be sold for a certain period. This holding period on a stock dividend typically begins the day after it is purchased.

Dilution Effect

The board of a public company may approve a 5% stock dividend. That gives existing investors an additional share of company stock for every 20 shares they already own. However, this means that the pool of available stock shares in the company increases by 5%, diluting the value of existing shares.

Therefore, an investor who owned 100 shares in a company will own 105 shares once the dividend is executed, but the total market value of those shares remains the same. In this way, a stock dividend is similar to a stock split.

Advantages and Disadvantages of Stock Dividends

Pros and Cons for Companies and Investors

Pros

Company's cash balance remains the same
Decrease in share price may attract new investors
Stock dividends are not treated as taxable for investors until sold

Cons

Bonus shares dilute the share price
Stock dividends may signal financial instability for the company
Less cash income for the investor

Small vs. Large Stock Dividends

When a stock dividend is issued, the total value of equity remains the same from both the investor's perspective and the company's perspective.

All stock dividends require an accounting journal entry for the company issuing the dividend. This entry transfers the value of the issued stock from the retained earnings account to the paid-in capital account.

Small Stock Dividend

A stock dividend is considered small if the shares issued are less than 25% of the total value of shares outstanding before the dividend. A journal entry for a small stock dividend transfers the market value of the issued shares from retained earnings to paid-in capital.

Company X declares a 10% stock dividend on its 500,000 shares of common stock. Its common stock has a par value of $1 per share and a market price of $5 per share.

When the small stock dividend is declared, the market price of $5 per share is used to assign the value to the dividend as $250,000 (500,000 x 10% x $5). The common stock dividend distributable is $50,000 (500,000 x 10% x $1) since the common stock has a par value of $1 per share.

Account	Debit	Credit
Stock dividends	250,000
Common stock dividend distributable		50,000
Paid-in capital in excess of par-common stock		200,000

When the company distributes the stock dividend it can make the journal entry:

Account	Debit	Credit
Common stock dividend distributable	50,000
Common Stock		50,000

Large Stock Dividend

Large stock dividends are those in which the new shares issued are more than 25% of the value of the total shares outstanding before the dividend. In this case, the journal entry transfers the par value of the issued shares from retained earnings to paid-in capital.

If Company X declares a 30% stock dividend instead of 10%, the value assigned to the dividend would be the par value of $1 per share as it is considered a large stock dividend and would make the following journal entry of $150,000 (500,000 x 30% x $1) by using the par value, instead of the market price.

Account	Debit	Credit
Stock Dividends	150,000
Common stock dividend distributable		150,000

What Is an Example of a Stock Dividend?

If a company issues a 5% stock dividend, it would increase the number of shares held by shareholders by 5%, or one share for every 20 owned. If there are one million shares in a company, this would translate into an additional 50,000 shares. A shareholder with 100 shares in the company would receive five additional shares.

Unlike a cash dividend, a stock dividend does not increase the value of the company. If the company was priced at $10 per share, the value of the company would be $10 million. After the stock dividend, the value will remain the same, but the share price will decrease to $9.50 to adjust for the dividend payout.

Why Do Companies Issue Stock Dividends?

A company may issue a stock dividend if it has a limited supply of liquid cash reserves. It may also choose to issue a stock dividend if it is trying to preserve its existing supply of cash. While issuing a stock dividend essentially dilutes the value of the outstanding shares because it increases the total supply of stock, if the shares were to rise in price, this can be advantageous for the shareholders.

What Is the Difference Between a Stock Dividend and a Cash Dividend?

While a stock dividend is paid out in the form of company shares, a cash dividend is paid out as cash. A company that has a 7% annual stock dividend would entitle the owner of 100 shares to 7 additional shares. Conversely, consider a company that issues a $0.70 annual cash dividend per share, which in turn, would entitle the owner of 100 shares to a total value of $70 in dividends annually.

The Bottom Line

A stock dividend is a dividend payment to shareholders that is made in shares instead of cash. The stock dividend rewards shareholders without reducing the company's cash balance, although it can dilute earnings per share. Stock dividends, as opposed to cash dividends, may signal financial instability and limited cash reserves. Stock dividends are not taxed for the investor until they are sold.

Article Sources

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Internal Revenue Service. "Publication 550: Investment Income and Expenses," Page 22.

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