Stock dividends are the dividends paid in the form of new stock rather than cash. This is also known as the bonus issue of shares. In general, companies pay 2-10% of stock dividends on the total shares outstanding.
When dividends are paid in this form, after the dividend payment there will be more shares outstanding, however, the value of each stock would have reduced. For example, assume that a shareholder has 10 shares of $10 each. The total value of shares is $100. If the company pays 10% stock dividends (1 new stock), the shareholder will now have 11 shares valuing $100. The value of each stock will now be 9.09.
Here are a few important points about stock dividends:
- The total number of shares for each shareholder increases.
- The company does not have to spend any extra cash to issue dividends.
- Stock dividends are not taxable, because there is no change in shareholder value.
- Stock dividends don’t change the ownership structure.
- Stock dividends don’t affect the shareholder’s wealth but the price of each stock reduces.
- Stock dividends are very commonly used in China.
- Stock dividends do not affect liquidity or financial leverage ratios because they don’t affect the assets or equity.
Let’s take a simple example to understand the impact of 10% stock dividends on shareholders.
|Before Dividends||After Dividends|
|Earnings per share||$1||$1/1.1 = 0.909|
|Stock price||$10||$10/1.1 = 9.09|
|Shares owned by a shareholder||100||110|
|Ownership value||100*10 = $1,000||110*9.09 = $1,000|
|Ownership percentage||100/100,000 = 0.1%||110/110,000 = 0.1%|
As you can see, there is no change in ownership value or ownership stake after stock dividends.