What Is a Stock Dividend?

What Is a Stock Dividend?

Let me explain directly: a stock dividend is when a company pays you, the shareholder, with additional shares of its stock instead of handing out cash. This approach dilutes the share price, but it lets the company hold onto its cash reserves for other needs.

These distributions come in fractions per share you already own. For instance, if the company declares a 5% stock dividend, you'll get 0.05 shares for each one you hold. So, if you own 100 shares, that means five extra shares coming your way.

Key Takeaways

Here's what you need to know upfront: a stock dividend means getting more shares in the company as your payment. You won't pay taxes on these until you sell them. Just like stock splits, this dilutes the share price since more shares are out there. Importantly, it doesn't change the company's overall value. Companies often choose this to reward you without touching their cash pile.

How a Stock Dividend Works

You should understand that companies issue stock dividends when they want to reward investors like you but either lack extra cash or prefer to save it for operations. This method keeps the cash balance intact, though it does bump up the company's liabilities.

For you as an investor, there's a tax perk: stock dividends aren't taxed until you sell those shares, unlike cash dividends which hit you right away.

Sometimes, these new shares come with a holding period—you can't sell them immediately, usually starting the day after you receive the dividend.

Stock Dividend Dilution

Be aware that issuing more shares for any reason leads to dilution. This reduces the earnings per share (EPS) for existing shares and cuts your ownership percentage.

The downside hits if the company's net income doesn't grow to match—dilution can hurt without proportional earnings increases.

Example of Stock Dividend Dilution

Let me walk you through an example. Before dilution, say a company has one million shares outstanding and earns $1 million—that gives an EPS of $1 per share.

After a 10% stock dividend, they issue 100,000 new shares, totaling 1.1 million. With earnings still at $1 million, EPS drops to about $0.91 per share. That's dilution in action.

Pros and Cons for Companies and Investors

From the company's side, this rewards you while keeping cash on hand, and the lower share price might draw in new investors. For you, no taxes until sale is a plus.

On the flip side, it dilutes the share price, could signal the company is in financial trouble, and some investors prefer cold hard cash over more shares.

Advantages and Disadvantages of Stock Dividends

As an investor, you might not see immediate benefits from stock dividends, but remember, taxes are deferred until you sell. Issuing them drops the stock price short-term, which can attract buyers and potentially benefit you later. You could even sell the extras right away, cash in, and keep your original shares.

Companies aren't obligated to pay dividends on common stock, but stopping or cutting them looks bad. For them, stock dividends are an easy way to pay out without draining reserves.

Journal Entries for Stock Dividends

Know that the total equity value stays the same for both you and the company when a stock dividend is issued. The company must record this with a journal entry, moving value from retained earnings to paid-in capital.

Small Stock Dividend Accounting

If the dividend is small—less than 25% of outstanding shares—the entry uses market value to transfer from retained earnings to paid-in capital.

Take Company X with 500,000 shares at $1 par and $5 market price, declaring a 10% dividend. The value is $250,000 (500,000 x 10% x $5), with distributable at $50,000 (500,000 x 10% x $1), and excess to paid-in capital.

Large Stock Dividend Accounting

For large dividends—over 25%—use par value instead. If it's 30%, the entry is $150,000 (500,000 x 30% x $1), transferring directly.

What Is an Example of a Stock Dividend?

Simply put, a 5% stock dividend increases shares by 5%, or one for every 20 you own. With one million shares out, that's 50,000 new ones; if you have 100, you get five more.

Why Do Companies Issue Stock Dividends?

Companies do this to give you a slice of profits as a reward for holding shares, opting for stock over cash to keep reserves intact.

What Is the Difference Between a Stock Dividend and a Cash Dividend?

Stock dividends give you more shares, taxable only on sale; cash dividends pay out money, taxable that year, with a 1099-DIV form.

Is a Stock Dividend a Good or Bad Thing?

Dividends are always positive, in shares or cash. If you want regular income, though, cash might suit you better.

What Is a Good Dividend Yield?

Typically, dividend stocks pay 2% to 5% annually; check the yield in stock listings to see payouts.

The Bottom Line

In essence, a stock dividend rewards you with extra shares instead of cash, keeping the company's money safe but temporarily diluting EPS. It might hint at cash shortages, offering no quick payoff but potential long-term value—or you can sell the extras for cash.