What Is a Stock Dividend?
A stock dividend is the award of extra shares in lieu of a cash payout to shareholders. They are also sometimes known as “scrip dividends.” Stock dividends allow companies to reward stockholders even when they’re low on operating cash, and are often contrasted with cash dividends.
There are a variety of different policies that companies operate under when it comes to issuing dividends, including residual, stable, and hybrid dividend policies.
- Residual dividend policies allow companies to reinvest equity into new projects before paying dividends to shareholders. The dollar amount of these dividends will vary from year to year, and using a residual dividend policy may allow for increased growth and profit over time.
- Stable dividend policies ensure that a company consistently pays out dividends each year, regardless of market volatility. Stable dividends usually represent a predetermined fraction of quarterly or yearly company earnings.
- Hybrid dividend policies combine residual and stable dividend policies in order to reward investors with a small, set dividend while still reinvesting earnings into future growth prospects.
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Stock Dividend vs Cash Dividend
When shareholders receive a stock dividend, they receive a certain percentage of additional shares in a company. When shareholders are issued a cash dividend, however, they receive an actual cash payout. There are a variety of different pros and cons to both stock and cash dividends.
Stock Dividend Pros and Cons
Stock dividends are often issued when a company doesn’t have a large supply of liquid cash available with which to reward shareholders. In these instances, stock dividends allow companies to compensate investors without having to liquidate any assets.
Stock dividends may also be profitable to shareholders, as they aren’t taxed until the shares are sold. This enables shareholders to continue growing their investment without paying any immediate tax penalties. Stock dividends facilitate stronger bonds between shareholders and a company, as shareholders now own a larger amount of stock in that company and are more invested in it.
While stock dividends are often a great option, they’re inconvenient if shareholders need immediate access to cash. However, shareholders always have the option of selling shares whenever necessary, so stock dividends can be converted into cash depending on the individual circumstances of the shareholder.
Cash Dividend Pros and Cons
Cash dividends are more attractive to investors looking for an immediate payout. Because the stock market is unpredictable, especially when it comes to shares of individual companies, cash dividends offer a safe alternative to stock dividends, and aren’t subject to the future whims of the market. Shareholders are also able to reinvest cash dividends into a company through a dividend reinvestment plan.
While cash dividends may be a less risky investment, they do have some drawbacks for both companies and shareholders. They require that a company has more cash on hand at any given time, which prevents the company from investing in new projects. They are also subject to tax penalties upon payout. Because investors are able to sell stock dividends at any time, cash dividends are often considered to offer less flexibility and choice for investors.
Why Do Companies Distribute Stock Dividends?
While rewarding shareholders may sound like a good idea, the decision to pay dividends or not isn’t always obvious. Some companies may decide not to pay dividends, and instead invest the majority of their profits in future growth. In addition, companies may not retain enough net profit each year for dividends to be financially feasible. Once a company decides to pay out dividends to shareholders, it can be difficult to reverse that decision in the future.
For companies that do decide to pay dividends, there are a variety of associated benefits. Companies are able to use dividends as a tool to increase investor interest in their stock, and to demonstrate the company’s profits in a tangible way. In general, investors are more likely to become shareholders in a company if that company issues dividends. Since many companies benefit when demand for their stock rises, they may be willing to pay out dividends to encourage an increase in demand.
How Are Stock Dividends Distributed?
Companies use a variety of different methods to distribute stock dividends. In general, companies issue stock dividends based on a percentage. For example, if a company decides to issue a 5% stock dividend to shareholders, shareholders will receive one additional share for every 20 shares they already possess. If a shareholder already owns 100 shares in a company, they’ll own 105 after a 5% stock dividend is issued. When this happens, the overall value of the company remains the same, so the value of each share is slightly diluted.
When Do Companies Pay Dividends?
Dividends are usually paid out quarterly. However, while quarterly dividends are the industry standard, companies are not required to issue dividends on a quarterly basis. The percentage of stock dividends issued is usually determined by the company’s earnings for that quarter.
When Stock Dividends Are Declared and Issued
Dividends are typically declared and issued after the close of a quarter when a company determines its income statement. The declaration date is when shareholders are notified of the stock dividend for that quarter. The company also sets a record date sometime before the payment, after which any new investors are no longer eligible for the dividend. Stock dividends are usually issued approximately one month after the record date.
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This post was updated November 26, 2019. It was originally published November 26, 2019.