What is a stock dividend?
It's a dividend payment that a company gives to its existing stakeholders from the profit or earnings it made during a financial year which is paid in additional shares rather than cash. They're also called scrip dividends or bonus shares.
Where have you heard about stock dividends?
You may hear about companies issuing stock dividends if they want to reward their investors, but they either have a short supply of cash on hand or they want to reinvest any existing liquidity in the business.
What you need to know about stock dividends...
If a company allocates additional stock to its stakeholders it doesn't increase the total value of the company; instead, it reduces the value of each share.
With a 10% stock dividend a stakeholder may end up with 110 shares instead of 100, but because the amount of shares in the company has increased proportionately, the value of these shares will have gone down by 10%. So, ultimately, the total value of a given stake hasn't changed.
An advantage of stock dividends, as opposed to cash dividends, is that you won't pay tax on your stock dividends until you sell your shares.
You also have the benefit of choice: you can choose to either keep the shares and hope for a better rate of return in the future or you can decide to sell some or all of the new shares to make what effectively is a cash dividend.
If a company decides to pay a dividend to its shareholders, it declares the amount and the payable date.
Usually, the date is set every quarter after the company releases its earnings reports and the company’s management reviews the financials. A dividend payment in the form of additional stock is also known as dividend reinvestment or DRIPs.
Depending on the ratio of newly issued shares to the total value of outstanding shares before the dividend, stock dividends may be large and small.
If the value of newly issued shares exceeds twenty-five percent of the total value of shares outstanding before the dividend payout, it is considered a large dividend stock payment. Otherwise, it is called a small stock dividend payment.
Advantages of stock dividends for companies:
Saving the company’s cash. If the company does not have enough cash to pay dividends, it can pay in shares;
Increasing share liquidity. By issuing more stock, the company reduces the price of each individual share, which may help to increase the liquidity of the shares.
Disadvantages of stock dividends for companies:
Stock dividend payouts may be considered as a sign of distress or cash shortage;
It can also be a sign that the company is involved in risky projects.
In general, dividend-paying stocks are considered as safe and sound investments. Traders always prefer the companies which pay dividends.