A dividend is classified as a stock dividend when a company issues stock to shareholders as a form of compensation. For accounting purposes, when a company issues less than 25% of its outstanding shares, the transaction is considered to be a stock dividend.
Companies generally pay dividends as a share of their profits each quarter, annually, or at a moment determined by the company's board of directors.
Most frequently, companies pay cash dividends, which are direct cash payments in accordance to how many shares a shareholder owns. However, they also have other options for dividend payments, including property dividends, scrip dividends, liquidating dividends and stock dividends.
- Property dividends allow the payment of a non-monetary dividend, rather than cash or stock
- Scrip dividends allow the payment of a promissory note, or I.O.U., to pay shareholders at a later date
- Liquidating dividends allow for return of capital originally contributed by shareholders as a dividend, and they're sometimes issued as a precursor to shutting down a business.
Stock Dividends: Slicing the Equity Pie
Stock dividends differ slightly from stock splits, which are characterised by a payment in stock of more than 25% of outstanding shares. Generally, stock dividends are issued from a company's own stock, or "retained earnings."
There are several possible reasons a company may choose to issue a stock dividend. One reason could be that it doesn't have enough cash on hand to make a cash dividend payment, but desires to make some form of payment to shareholders to maintain investor confidence in the company. Another possible reason is to increase the number of outstanding shares in the market, broaden ownership of the stock and increase the liquidity of its shares. Another reason to issue stock dividends could be to capitalise a portion of retained earnings. Such a reduction of retained earnings can be used as a means of limiting the possibility of future dividend payments.
The Dividend Payment Process
At the end of each quarter, the company will declare its earnings in its quarterly financial statement. The company's board of directors will then decide how much of these earnings will be paid out to shareholders and how much will be reinvested in the company.
On what is called the "date of declaration," the board of directors defines a certain dividend amount to be paid to investors holding the company's stock on a specific date. On the "date of record," the dividends are assigned to the holders of the company's stock. On the "date of payment," the company makes payment of the dividends.
Stock dividends can be considered similar to cash dividends in that each shareholder is eligible to receive a certain number of additional shares based on the number of shares they already hold. If a shareholder owns 1,000 shares of a company valued at US$10 per share and the company issues a 6% stock dividend, the shareholder will receive 60 shares of stock as a dividend payment. As with other types of dividends, the fair value of shares issued toward stock dividends is based on their fair market value when the dividend is declared.
Advantages And Disadvantages Of Stock Dividends
Stock dividends may at times be seen as more attractive for investors, as payment in stock dividends is usually not considered taxable income by tax authorities. For a long-term investor, a stock dividend can also be a way of re-investing in a company that may grow and increase equity value in the future. A related benefit is that investors planning to buy more of a particular stock can avoid broker commission fees in acquiring more shares.
Another advantage for investors is that the stock dividend issue may send a signal to the market that the company is in good financial health. Further, the greater liquidity of the shares could encourage more buying and selling of the shares, thus helping to boost their price under the right market conditions.
However, for investors who are seeking cash dividend income from their stock holdings, a stock dividend could be considered undesirable. Another negative effect of a company's decision to issue a stock dividend is that it will possibly dilute the value of the shares, as there will be more shares outstanding in the market. A related effect of this is that if the share value doesn't increase, then earnings per share of the company will likely be lower in the following earnings season.
While cash dividend payments are more common, a payment of stock dividends can be a welcome event contributing to the growth of investors' portfolios. But more importantly they can give investors a clue as to the company's financial health, including its cash position, ability to make future dividend payments, and the likelihood its shares and dividend payments will grow in the near future. Although stock dividends may or may not be an indication of an alteration in a company's present financial strength, they often prompt a reaction in the market and may serve as a sign to investors of possible changes to come.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…