Definition
A stock dividend is a payment made by a corporation to its shareholders, usually in the form of additional shares of stock rather than cash. It’s issued from the company’s existing shares of stock and is distributed proportionally to all shareholders. As a result, the stock’s price per share decreases, but the total number of shares increases.
Key Takeaways
- A stock dividend is a distribution of shares by a corporation to its shareholders, usually in the form of additional shares. Instead of cash, shareholders receive shares of stock that the company has on hand.
- This type of dividend is used when the company wants to conserve cash, and it also reduces the price of the individual shares as the number of shares outstanding increases.
- Stock dividends have tax implications. They are generally not taxed until the shares are sold, and then they are taxed at the capital gains rate instead of the higher dividend rate.
Importance
Stock dividends are an important aspect of finance because they represent a significant portion of an investor’s returns over the long term. They are a means by which companies distribute their profits back to their shareholders, usually in the forms of additional shares.
This not only increases the total number of shares owned by each investor, but also decreases the price per share, making the stock more affordable for new investors. For current shareholders, stock dividends can increase their ownership stake and potential returns without requiring them to invest more capital.
Furthermore, it’s a sign that a corporation is financially healthy with good profitability, thus enhancing the attractiveness of the company’s stock and potentially driving the share price higher over time. It’s a strategic tool that can help companies maintain investor satisfaction and can lead to increased investment in the company.
Explanation
The purpose of a stock dividend is to reward shareholders of a corporation’s stock by issuing additional shares instead of paying cash. This structure can be particularly beneficial for companies who want to preserve their cash holdings for other reinvestments or company needs.
It provides shareholders with a larger quantity of shares, thus increasing their ownership stake in the company, and is often employed as a method to incentivize and reward long-term investment in the company. It’s a way for companies to distribute profit back to their shareholders, without affecting their cash flow.
Stock dividends tend to result in a reduction of the stock price, proportional to the size of the dividend, as the total value of the shares remains the same. However, the reduction in stock price may be offset by an increase in demand, as some investors may perceive the increased share volume as an opportunity for potential future growth.
Moreover, shareholders may sell these extra shares for immediate cash need, or hold them from a long-term perspective. Therefore, stock dividends can be beneficial from both the company’s and the investor’s perspective.
Examples of Stock Dividend
Apple Inc.: Known for its innovative technology products, Apple Inc. is also popular for providing regular dividends to its shareholders. For instance, in 2014, the company issued a 7-for-1 stock dividend. This meant that an investor owning one share of Apple, received an additional six shares of the stock as a dividend.
IBM: Another example of a company issuing a stock dividend is IBM, which has a long history of stock dividends. Since IBM was struggling to have enough cash to pay high dividends during the mid-1990s, it opted to issue a stock dividend to reward shareholders without having to provide a significant cash outflow.
Berkshire Hathaway: The famous Warren Buffet’s company, Berkshire Hathaway, does not pay cash dividends but has often taken part in stock dividends. In the 1960s, the company initiated a policy to buy back shares using company assets which essentially leads to stock dividends for shareholders as the ratio of earnings per share increases.
Stock Dividend FAQ
What is a Stock Dividend?
A stock dividend is a dividend payment made in the form of additional shares rather than a cash payout. Companies may decide to distribute this kind of payment to shareholders of record if the company’s availability of liquid cash is in short supply.
How is a Stock Dividend different from a Cash Dividend?
In a cash dividend, the company distributes earnings to its shareholders in cash. Whereas, a stock dividend is a payment made to shareholders in the form of additional shares. Companies may opt for stock dividends when they wish to reward their investors but are low on liquid cash, or when they wish to reinvest their profits back into the business.
How does a Stock Dividend affect Stock Price?
When a company declares a stock dividend, it could lead to a decrease in the price per share. This is because the total equity of the company remains the same, but it’s now spread across more shares. Consequently, each share’s value decreases even though the total market capitalization of the company remains the same.
What are the Benefits of a Stock Dividend to the Investor?
Stock dividends can be beneficial as they increase the number of shares owned by investors. This can lead to an increase in the total income received from dividends in the future if the company performs well. Moreover, the investor could also profit by selling the additional shares received at a higher price in the market if the stock price increases.
How is a Stock Dividend taxed?
A stock dividend is typically not taxed until the shares are sold. This is because a stock dividend generally does not change the overall value of the investor’s position. The cost basis for the original shares and the new dividend shares is averaged together.
Related Entrepreneurship Terms
- Dividend Payout Ratio
- Ex-Dividend Date
- Retained Earnings
- Declaration Date
- Stock Split
Sources for More Information
- Investopedia: A comprehensive source of financial information, including an entry specifically about stock dividends.
- The Motley Fool: A multimedia financial-services company that provides advice for investors with various investment styles, with articles relating to stock dividends.
- Fidelity: A broad financial services firm with a detailed knowledge center that can provide insights about stock dividends.
- Charles Schwab: A bank and brokerage firm that offers a wide range of resources for investors, including material on stock dividends.
