A stock dividend is a kind of dividend in which owners get extra shares of stock rather than cash as payment.
What Is A Stock Dividend?
Typically, dividends declared by firms are paid out in cash. However, occasionally a business may decide to choose a stock dividend over a cash payout.
In this instance, the dividend is given to shareholders in the form of more business shares rather than cash. For instance, if a corporation paid a 5 percent stock dividend, its owners would receive 5 additional shares for every 100 they already held. The board of directors of a corporation determines if and when dividends should be paid out, as well as whether they should be in the form of cash or shares.
How Do Stock Dividends Work?
A stock dividend acts more similarly to a stock split than a cash dividend, technically speaking. A stock dividend often doesn’t result in an immediate tax obligation when it is issued. Instead, it alters the owner’s shares’ cost basis when they are finally sold.
A cash dividend, on the other hand, often results in tax obligation in the year that it is distributed.
If a stock dividend results in the distribution of a fractional number of shares to shareholders, this rule is an exception. In rare circumstances, a business will distribute cash instead of fractional shares, generating some immediate taxable revenue.
Why Companies Issue Stock Dividends
A stock dividend might have a few advantages for the corporation issuing it. One benefit is that it can result in a high stated yield, which tends to draw particular types of investors. If the corporation had to pay for it out of existing funds, that kind of yield might not be feasible to give.
Notably, a stock dividend enables a business to maintain a substantial stated dividend yield without actually paying out all of that money to shareholders.
Another advantage is that, unlike traditional cash dividends, it does not immediately subject stockholders to tax responsibility. This enables a business to reward shareholders annually without having to pay out cash or have immediate tax repercussions, therefore fostering a sense of loyalty.
Impacts Of Stock Dividends
Pizzas provide a great comparison to stock dividends. Pizza may be divided into 8, 10, 12, or even 16 pieces, and the serving size remains the same. Similar to a cash dividend, a stock dividend changes the number of shares outstanding without changing the corporation’s underlying assets.
Dividends on stocks are not a free meal. Each share reflects a reduced ownership position in the entire company, even though the owner receives more shares in their account.
Or to put it another way, a stock dividend is a type of dilution. For instance, with a 5% stock dividend, a shareholder would now possess 105 shares of a $9.52 stock, assuming the market would continue to rise.
Small Vs. Large Stock Dividends
Usually, the size of the distribution in relation to the number of shares outstanding distinguishes between a high and small stock dividend. Small stock dividends are those that are less than 25% of the current share count, and large stock dividends are those that are larger than that.
Large stock dividends are somewhat uncommon since businesses often choose to split their stock rather than issue a huge number of shares through a large stock dividend. There is a distinct accounting procedure in the event of a sizable stock dividend, with the record price based on the stock’s par value rather than its fair market value.
Stock Dividends Vs. Cash Dividends
Right there in the name is the primary distinction between a stock dividend and a cash dividend. A stock dividend replaces cash payments with more shares of the corporation. The shares an owner receives can be sold for cash, but it would dilute their ownership interest in the business.
Taxes are another area where there is an effect. In most cases, when businesses distribute cash dividends to shareholders, it is considered a kind of income, and the money received must be taxed. In contrast, a stock dividend doesn’t immediately result in a tax burden because no real money is exchanged.
Stock Dividend Example
In cyclical sectors with inconsistent cash flows, like banking, stock dividends are increasingly prevalent. Consider a scenario in which there was a new financial crisis and a bank was worried about possible loan losses on its credit portfolio. During the downturn, it can opt from paying a cash dividend and instead move to a stock dividend.
Shares at $10 may have typically paid a 50-cent dividend or a 5% annual yield. The bank chooses to move to a stock dividend, however, as cash flows appear to be unclear. The investor will now get 5 additional shares of the bank’s stock for every 100 shares they now own, as opposed to 50 cents per share in cash each year.
Bottom Line
Companies have another option to reward shareholders: stock dividends. They could more closely resemble an accounting trick than a genuine capital return. They do, however, have certain benefits, such as minimizing short-term tax obligations and protecting a company’s capital while providing investors with a dividend. Just be mindful of stock dividend dilution plans.
