Stock Dividend

Key takeaways

• A stock dividend pays shareholders additional company shares instead of cash, preserving corporate cash while increasing outstanding shares.
• Stock dividends typically are not taxed when received; tax consequences usually arise when shares are sold (check local tax rules).
• Issuing new shares dilutes earnings per share (EPS) and ownership percentage unless earnings grow proportionally.
• Accounting differs for small (less than 25%) and large (25% or more) stock dividends.

What is a stock dividend?

A stock dividend is a distribution of additional shares to existing shareholders rather than a cash payment. It is usually expressed as a percentage (for example, a 5% stock dividend gives 0.05 extra shares per share owned). The company keeps its cash but increases the number of shares outstanding, which typically lowers the share price proportionally.

How stock dividends work

• Payment: Shareholders receive additional shares based on their holdings (e.g., 5% means 5 extra shares for every 100 owned).
• Share count: Total outstanding shares rise; the company’s total equity value does not change immediately.
• Price effect: The per-share market price typically falls to reflect the larger share count.
• Holding restrictions: Some stock dividends may have a short holding period before the new shares can be sold.
• Tax treatment: In many jurisdictions, stock dividends are not taxed when received; tax is generally triggered when the shares are sold. Rules and exceptions vary, so consult a tax advisor.

How stock dividends cause dilution

Issuing new shares reduces each existing shareholder’s ownership percentage and lowers EPS if net income remains unchanged.

Example:
– Before: 1,000,000 shares outstanding, $1,000,000 net income → EPS = $1.00
– After a 10% stock dividend: 1,100,000 shares outstanding, same $1,000,000 net income → EPS ≈ $0.91

Dilution is a concern if additional shares are not accompanied by proportional earnings growth.

Why companies issue stock dividends

• Conserve cash while still rewarding shareholders.
• Make shares more affordable by reducing the per-share price.
• Signal reinvestment of earnings into growth rather than cash payouts (though frequent stock dividends can also signal limited cash availability).

Pros and cons

Pros
* Preserves corporate cash.
Tax deferral for shareholders (usually until sale).
Lower per-share price may attract new investors.

Cons
* Dilutes EPS and ownership percentage.
May signal restricted cash flow, which some investors view negatively.
Less attractive to investors seeking immediate cash income.

Accounting for stock dividends

Total shareholders’ equity remains the same; the accounting entries reclassify amounts within equity (typically from retained earnings to paid-in capital).

Small stock dividends (less than 25%)
* Value the dividend at market price.
When declared: debit Retained Earnings for the market value of shares to be issued; credit Common Stock Dividend Distributable (at par value) and Additional Paid-In Capital (for excess over par).
When distributed: debit Common Stock Dividend Distributable; credit Common Stock (at par).

Example (Company X)
– Shares outstanding: 500,000
– Par value: $1.00
– Market price: $5.00
– 10% dividend → 50,000 new shares
– Total market value = 50,000 × $5 = $250,000
– Par value portion = 50,000 × $1 = $50,000
Journal entries:
– On declaration: Debit Retained Earnings $250,000; Credit Common Stock Dividend Distributable $50,000; Credit Additional Paid-In Capital $200,000.
– On distribution: Debit Common Stock Dividend Distributable $50,000; Credit Common Stock $50,000.

Large stock dividends (25% or more)
* Value the dividend at par value.
When declared: debit Retained Earnings for the par value of shares to be issued; credit Common Stock Dividend Distributable (at par).
When distributed: debit Common Stock Dividend Distributable; credit Common Stock.

Example (same company with 30% dividend)
– New shares = 500,000 × 30% = 150,000
– Par value portion = 150,000 × $1 = $150,000
Journal entry on declaration: Debit Retained Earnings $150,000; Credit Common Stock Dividend Distributable $150,000.
On distribution: Debit Common Stock Dividend Distributable $150,000; Credit Common Stock $150,000.

Stock dividend vs. cash dividend

• Stock dividend: paid in shares, typically not taxable on receipt (taxed on sale), preserves company cash.
• Cash dividend: paid in cash, taxed in the year received, reduces company cash reserves.
  Investor preference depends on objectives: income-seeking investors often prefer cash; long-term growth investors may accept stock dividends.

Is a stock dividend good or bad?

Neither inherently good nor bad—it depends on circumstances and investor goals. Stock dividends preserve company cash and can support longer-term value creation, but they dilute EPS and may disappoint income-focused shareholders.

Typical dividend yield

Dividend yield varies by company and strategy. A common range for dividend-paying stocks is roughly 2%–5% annually, though yields can be lower or substantially higher depending on the company and sector.

Bottom line

Stock dividends increase the number of shares outstanding without immediately changing a company’s total value. They conserve corporate cash and can offer tax deferral benefits for shareholders, but they dilute EPS and ownership percentages. Whether they are advantageous depends on company financials and investor objectives; consult accounting and tax professionals for specifics.