A Guide to Stock Dividend

During your investment journey in stock markets, you must have often heard the term, stock dividends. They’re like a special reward for investors. In simple terms, stock dividends are a way companies share their success with you. In this article, we’ll explore what stock dividends mean, their impact, pros and cons. 

What Is a Dividend?

Before understanding stock dividends, you must know about dividends. Any company listed on the stock exchange rewards its shareholders through dividends. 

Dividend payments are dependent upon the net profit being made by the company. The board of directors of a company decide the terms of dividend issuance, which, in turn, has to be approved by the key shareholders. The company can pay dividends in various forms, such as cash, assets or stocks.

What Is a Stock Dividend?

When the company makes dividend payments to its shareholders in the form of additional shares – instead of cash payment – it is known as a stock dividend or stock bonus. 

Here, you must remember that the additional stocks must be less than 25% of the company’s previously issued stocks. If the company issues more than 25% of additional stocks, it classifies as a stock split. The stock dividend payment can be made when the company does not have sufficient cash to make dividend payments or wants to preserve its cash for other investment purposes.

To help you understand such dividend payments better, here is a stock dividend example. Suppose XYZ company, with 10 lakh shares in the market, issues 5% stock dividends, then it implies an additional issuance of 50,000 stocks. If you owned 100 shares of XYZ company, you would receive 5 additional shares. 

Usually, stock dividends in India are paid to shareholders on a pro-rata basis. Suppose XYZ company issues stock dividends on a 1:5 basis; it means that each shareholder will receive an additional 5 shares for each share they hold.

Impact of Dividend Stocks

There are two perspectives here: one is the impact of stock dividends on individual shareholders, and the other is the impact on the market capitalisation of the issuing company. 

Issuance of dividend stocks does not increase the wealth of existing shareholders, nor does it increase the market value of the publicly traded company’s outstanding shares (market capitalisation). For individual shareholders, although the number of stocks being owned increases, there is also a corresponding decrease in the price of each share. This is because the company’s market capitalisation has not increased.

Let’s understand the scenario with another stock dividend example. Suppose you are a shareholder of XYZ company and own 1,000 shares with a market price of ₹10 per share. If the company announces a 10% stock dividend, you will now have 100 additional shares. Meanwhile, the market capitalisation of XYZ company is ₹10 lakh with 1 lakh outstanding shares. After announcing the stock dividend, the total number of shares will increase to 1.10 lakh, while the stock price will decrease to ₹9.09 (1,00,000*10/1,10,000 = ₹9.09). 

Here’s a simple table to understand the impact for the shareholder and the company: 

Meanwhile, for XYZ company

Thus, from the above-mentioned example, you can see that the issuance of dividend stocks does not impact the total value of shares being held by shareholders as market capitalisation of the issuing company remains the same.

Benefits of Issuing Dividend Stocks

• Allows the company to maintain its cash reserve: The foremost benefit of issuing dividend stocks is that it can allow the company to maintain its existing cash reserve. As this type of dividend payment requires zero cash transactions, the company can use its current cash reserve for investment and business purposes.
• Tax implications for issuing dividend stocks: For individual shareholders, stock dividends involve zero tax consideration when receiving the additional stocks. There are tax implications – either as short-term capital gains tax or long-term capital gains tax – only when such stocks are subsequently sold for a profit. Conversely, cash dividends have tax implications. 
• Makes the stocks more affordable for common investors: Once the company announces dividend stocks, it results in a decrease in the market value of shares. This can make the stocks more affordable to common investors, thereby encouraging them to purchase such stocks. In other words, it can allow the company to maintain an investable price range.

Disadvantages of Issuing Dividend Stocks

• Wrong signal of the company being in financial duress: If a company announces the issuance of dividend stocks, then market participants might wrongly perceive it as the company facing difficulties in having an adequate cash reserve. While from the company’s standpoint, there could be multiple reasons justifying the issuance of dividend stocks, such an issuance can be incorrectly interpreted. This, in turn, can have an adverse impact on the company’s stock prices.
• Misinterpreting dividend stock issuance as a signal for the company’s investment in risky projects: There can also be a likely scenario of the market participants wrongly perceiving the issuance of dividend stocks as the company using its cash reserve for investing in speculative business ventures. This can negatively impact its stock prices.

Conclusion

Thus, dividend stocks are additional shares issued to existing shareholders as a reward. This type of dividend payment has its unique features and benefits along with some disadvantages. Now that you know about stock dividends, make your investment journey in stock markets hassle-free by selecting a trusted and reliable stockbroker like Angel One. Open a Demat account on Angel One today. 

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