What Is a Stock Dividend?
A stock dividend is a payment to shareholders that consists of additional shares rather than cash.
The distributions are paid in fractions per existing share. For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. The owner of 100 shares would get five additional shares.
- 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 are sold by their owner.
- Like stock splits, stock dividends dilute the share price because additional shares have been issued.
- They do not affect the value of the company.
- A company may prefer to pay dividends in stock rather than cash in order to preserve its cash reserves.
What Is A Dividend?
How a Stock Dividend Works
Also known as a scrip dividend, a stock dividend may be paid out when a company wants to reward its investors but either doesn't have the spare cash or prefers to preserve it for other uses. The stock dividend has the advantage of rewarding shareholders without reducing the company's cash balance.
Stock dividends have a tax advantage for the investor as well. Like any stock shares, stock dividends are not taxed until the investor sells the shares.
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 received.
The board of a public company may approve a 5% stock dividend. That gives existing investors one additional share of company stock for every 20 shares they currently own. However, this means that the pool of available stock shares in the company increases by 5%, diluting the value of existing shares.
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
From the investor's viewpoint, there's little immediate reward in receiving stock dividends. Then again, there's no tax due until the additional shares are sold.
Issuing share dividends lowers the price of the stock, at least in the short term. A lower-priced stock tends to attract more buyers, so current shareholders are likely to get their reward down the road. Or, they can sell the additional shares immediately, pocket the cash, and still retain the same number of shares they had before.
A public company is not required to issue dividends at all. However, it's not a good look for a company to abruptly stop paying dividends or pay a lower dividend than it has in the past.
For the company, a stock dividend is a pain-free way to issue dividends without depleting its cash reserves.
Pros and Cons for Companies and Investors
Company's cash balance remains the same
Decrease in share price may attract new investors
Investors do not owe tax on these dividends until the stock is sold
Bonus shares dilute the share price
Stock dividends may signal the company's financial instability
Less cash income for the investor
Journal Entry: Small and 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 Accounting
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.
|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:
|Common stock dividend distributable||50,000|
Large Stock Dividend Accounting
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.
|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 shares owned. If there are one million shares in a company outstanding, 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 rather than cash if it doesn't want to deplete its cash reserves.
Dividends, whether in cash or in stock, are the shareholders' cut of the company's profit. They also are a reward for holding the stock rather than selling it.
Companies decide whether to issue a dividend and how much it will be, based on the size of their profits.
In recent years, many fast-growing companies haven't paid dividends at all. Their fast-growing stock prices are all the reward that their investors demand.
Other companies are touted as "dividend aristocrats." They always pay dividends and they tend to increase the size of their dividends over time.
What Is the Difference Between a Stock Dividend and a Cash Dividend?
A stock dividend is paid out in the form of company shares. The stock dividend is not taxable until the shares are sold.
A cash dividend is paid out as cash. It's taxable for that year. The company will send you a 1099-DIV form at the end of the year.
A company that has a 7% annual stock dividend would pay the owner of 100 shares seven additional shares. If the company had instead offered a $0.70 annual cash dividend per share, the owner of 100 shares would receive $70 in dividends for the year.
Is a Stock Dividend a Good or Bad Thing?
Dividends are always a good thing, whether they're in shares or in cash.
However, if you're buying dividend-paying stocks in order to create a regular source of income, you would prefer to get the cash.
If your goal is steady income, you might look to invest in one of the so-called dividend aristocrats. These are stable, successful companies that have a long history of paying cash dividends and increasing the size of the dividends over time.
Most are mature companies that are past their fastest growth periods. But if you're holding them for income rather than trading them, that won't matter to you.
There also are a number of exchange-traded funds (ETFs) that are benchmarked to the S&P Dividend Aristocrats Index.
What Is a Good Dividend Yield?
A dividend-paying stock generally pays in a range of 2% to 5% annually, whether in cash or in shares. Dividend aristocrats are at the higher end of that scale.
When you look at a stock listing online, check the "dividend yield" line to find out what the company is currently paying out.
The Bottom Line
A stock dividend is a payment to shareholders that is made in additional shares instead of cash.
The stock dividend rewards shareholders without reducing the company's cash balance. It has the adverse effect of diluting earnings per share.
Stock dividends may signal financial instability, or at least limited cash reserves.
For the investor, stock dividends offer no immediate payoff but may increase in value in time.
Internal Revenue Service. "Publication 550: Investment Income and Expenses," Page 22.
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