What is Scrip Dividend? Meaning, Calculation & Example

In finance, unfamiliar terms can pop up like surprise quizzes. Today, we’ll tackle one such term: Scrip Dividend. Don’t worry; it’s not as complicated as it sounds! This article will briefly break down Scrip Dividend, making you a financial whiz in no time.

What is a Dividend?

Before diving into Scrip Dividends, let’s understand a regular dividend. Imagine a company that has a successful year and earns a profit. This profit belongs to the shareholders—people who own a piece of the company through stocks.

A company can choose to share this profit with its shareholders in two ways:

Cash Dividend: The company simply distributes a portion of the profit as cash directly into shareholders’ accounts. It’s like receiving a bonus for contributing to the company’s success!
Stock Dividend: Instead of cash, the company issues additional shares to shareholders, which is like getting more ownership certificates in the company.

Know More About Difference between Cash Dividend and Stock Dividend

What Is Scrip Dividend?

A Scrip Dividend is a twist on the regular stock dividend. Here’s how it works:

The company decides to distribute a dividend, but it doesn’t have enough readily available cash. Maybe they’ve reinvested profits into expanding the business.

Instead of skipping the dividend altogether, they offer a Scrip Dividend, which means they issue Scrips to their shareholders.

Think of a Scrip as a promise note. It’s like the company saying, “We don’t have the cash right now, but we owe you a specific amount based on your shareholding. We’ll give you cash later when we have enough funds.”

Here’s the key difference: Unlike a regular stock dividend, a Scrip doesn’t immediately give you additional shares in the company. It’s a temporary document representing the future claim on the company’s cash.

How Does Scrip Dividend Work?

When a company decides to issue a Scrip Dividend, they’re essentially offering shareholders a choice. Instead of receiving the usual cash dividend, shareholders can opt for additional shares in the company. Here’s how it works:

Declaration and Choice: The company announces the dividend and informs shareholders about the option to receive Scrip (the document representing the future claim on cash) instead of cash.
Discounted Shares: These additional shares offered through a Scrip Dividend are often issued at a price lower than the current market value. This incentive encourages shareholders to choose the Scrip option.
Calculation Based on Holdings: The Scrip Dividend a shareholder receives is directly linked to the number of shares they already own in the company. In simpler terms, the more shares you hold, the larger your Scrip Dividend (and potential future cash payout).

Key Points to Remember:

Scrip Dividends act as a deferred cash payment. You don’t receive immediate cash, but the company promises to pay you later based on the Scrip value.
The lower price of the additional shares can make Scrip Dividends attractive, especially for shareholders looking to increase their ownership in the company at a discount.

Calculating Your Scrip Dividend Payout

So, you’ve understood the concept of Scrip Dividends and how they offer additional shares instead of cash. But how do you figure out how many extra shares you’ll receive?

Here’s a breakdown of the calculation process:

The Formula:

There’s a formula that helps determine the number of additional shares you’ll get through a Scrip Dividend. It considers three key factors:

Dividend Amount: This is the value per share the company has declared as a dividend.
Market Price per Share: This is the current price of a single share of the company’s stock in the market.
Discount Rate: This represents the reduction in price offered by the company for the additional shares through the Scrip Dividend. It’s basically a discount they provide to incentivise you to choose Scrip.

The formula itself looks like this:

Number of additional shares = (Dividend amount / Market price per share) * (1 – Discount rate)

Example in Action:

Let’s say Company ABC declares a Scrip Dividend with a 10% discount on the market price. The current market price per share is ₹40, and the dividend amount per share is ₹1.50. You own 200 shares in Company ABC.

Here’s how to calculate your Scrip Dividend payout:

First, calculate the effective share price after the discount:

Market price per share * (1 – Discount rate) = ₹40 * (1 – 0.10) = ₹36

Now, plug the values into the formula:

Number of additional shares = (₹1.50 / ₹36) = 0.0417 (rounded to four decimal places)

Since you can’t receive fractional shares, this translates to approximately 0.04 shares for each of your existing 200 shares.

Therefore, you would receive roughly 0.04 * 200 = 8 additional shares through the Scrip Dividend.

How Companies Issue Scirp Dividend?

Scrip Dividends offer shareholders a unique way to receive their dividends. Instead of the usual cash payout, these dividends involve additional shares in the company. Here’s a breakdown of the process for shareholders:

Announcement and Choice: The company kicks things off by announcing the dividend, just like they normally do. However, this time, shareholders are presented with an option: receive the dividend in cash (the traditional way) or opt for the Scrip Dividend, which translates to additional company stock.
Decision Deadline: Shareholders aren’t left hanging. The company provides a specific timeframe for deciding how they want to receive their dividend. This allows them to analyse their financial goals and choose the best option for their needs.
Opting for Scrip: If a shareholder chooses the Scrip Dividend route, they simply need to inform the company of their decision. This process is often straightforward, typically involving a form or an online selection.
Calculating Your Shares: The company then determines the additional shares a shareholder will receive. This calculation considers two key factors:

Original Dividend Amount: This is the value per share the company declared as a dividend (if it had been paid in cash).
Discount Rate (Optional): Sometimes, companies offer a discount on the market price for the Scrip Dividend shares. This incentive encourages shareholders to choose additional shares.

Issuing New Shares: Once the calculations are done and the shareholder confirms their choice, the company issues brand new shares directly to that shareholder. These new shares are added to the shareholder’s existing holding in the company.
Record Update: The company’s records are then updated to reflect the increased number of shares owned by the shareholder. This essentially signifies their increased ownership stake in the company.
Future Dividends: These newly acquired shares also have the potential for future dividends. Since they now own more shares, shareholders can expect a slightly larger payout when the company distributes dividends again.

Benefits of Scrip Dividends

Scrip dividends provide a seamless way for investors to increase their shareholdings without the hassle of traditional purchasing, offering a unique blend of convenience and growth opportunity. Here are the benefits of scrip dividends:

Simplified Reinvestment: Scrip Dividends streamline the reinvestment process. When a company offers shareholders the option to receive additional shares instead of cash dividends, it facilitates effortless reinvestment. Shareholders can increase their investment without the need to personally purchase additional shares.
Enhanced Compounding: Opting for Scrip Dividends means receiving additional shares that will themselves generate future dividends. This increment in share count can lead to a compounding effect, where the value and potential income from your investments grow progressively over time.
Adaptability for Individual Needs: Scrip Dividends provide flexibility, catering to diverse financial strategies and immediate cash needs. Shareholders can choose between receiving cash dividends for immediate liquidity or acquiring more shares for potential long-term benefits.
Opportunities for Growth: Accepting Scrip Dividends increases your stake in the company, which can lead to greater gains if the company’s stock value rises. This choice can enhance your potential for long-term investment growth.
Reduction in Transaction Costs: Acquiring shares through Scrip Dividends usually involves fewer transaction fees, such as brokerage costs, since the company typically absorbs these expenses. This means acquiring more shares without diminishing returns due to additional costs.

Limitations of Scrip Dividends

Despite their appeal, scrip dividends bring potential challenges such as tax implications and ownership dilution that shareholders must carefully consider. Let’s understand further:

Tax Considerations: Despite not providing immediate cash, Scrip Dividends might still incur taxes, which can affect the overall benefit of opting for additional shares instead of cash dividends.
Reduced Liquidity: While Scrip Dividends increase share ownership, they also result in less liquid assets compared to cash dividends, which might not be preferable for those needing immediate cash.
Risk of Dilution: Issuing additional shares through Scrip Dividends can dilute the ownership percentage of existing shareholders, similar to more people sharing a fixed amount of resources.
Potential for Lower Gains: The discounted price of shares received through Scrip Dividends might lead to lower returns compared to purchasing shares at the current market rate.
Administrative Complexity: Managing Scrip Dividends can introduce administrative challenges, complicating what might otherwise be a straightforward dividend receipt process.

Conclusion

Scrip Dividends are an innovative method for companies to reward their shareholders, blending the prospect of increased shareholding with the potential for enhanced future returns. They offer both advantages and drawbacks, making them a strategic choice depending on individual investment goals and circumstances.