Stock Dividend: What It Is and How It Works, With Example

A stock dividend is a payment to shareholders that consists of additional shares rather than cash. The distributions are paid in fractions per existing share. For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. The owner of 100 shares would get five additional shares.

Key Takeaways

  • A stock dividend is a payment to shareholders in the form of additional shares in the company.
  • Stock dividends are not taxed until the shares are sold by their owner.
  • Like stock splits, stock dividends dilute the share price because additional shares have been issued.
  • Stock dividends do not affect the value of the company.
  • A company may prefer to pay dividends in stock rather than cash to preserve its cash reserves.
Stock Dividend

Investopedia / Jessica Olah

How a Stock Dividend Works

A stock dividend may be paid out when a company wants to reward its investors, but either doesn't have the spare cash or prefers to save it for other uses. The stock dividend has the advantage of rewarding shareholders without reducing the company's cash balance. However, it does increase its liabilities.

Stock dividends have a tax advantage for the investor as well. Like any stock shares, stock dividends are not taxed until the investor sells the shares.

A stock dividend may require that the newly received shares not be sold for a certain period. This holding period typically begins the day after the dividend is received.

Stock Dividend Dilution

Stock dilution is reducing the earnings per share (EPS) and the ownership percentage of existing shareholders when new shares are issued. Unlike cash dividends, which are paid out of a company's earnings, stock dividends include the issuance of additional shares to existing shareholders.

Dilution starts when a company declares a stock dividend. It issues new shares in proportion to the existing holdings of shareholders. The total number of outstanding shares increases, leading to dilution.

When that happens, there is an EPS impact. The earnings are now divided over a larger number of shares, which can reduce the EPS if the company's net income does not increase proportionately. The ownership stake of each shareholder is diluted as the total number of shares increases, although they receive additional shares.

Example of Stock Dividend Dilution

An example of share dilution is as follows:

  • Before dilution: If a company has 1 million shares outstanding and earns $1 million, the EPS would be $1 per share.
  • After dilution: If a 10% stock dividend is issued, 100,000 new shares are created, making it 1.1 million shares. If the earnings are held constant at $1 million, the new EPS would be approximately $0.91 per share. Thus, the earnings are diluted.

Pros and Cons for Companies and Investors

Pros
  • The company's cash balance remains the same.

  • The decrease in share price may attract new investors.

  • Investors do not owe tax on these dividends until the stock is sold.

Cons
  • Bonus shares dilute the share price.

  • Stock dividends may signal the company's financial instability.

  • Share dividends may be less attractive to some investors than cash dividends.

Advantages and Disadvantages of Stock Dividends

From an investor's viewpoint, receiving stock dividends yields little immediate reward. Then again, there's no tax due until the additional shares are sold.

Issuing share dividends lowers the price of the stock, at least in the short term. A lower-priced stock tends to attract more buyers, so current shareholders are likely to get their reward down the road. Alternatively, they can sell the additional shares immediately, pocket the cash, and still retain the same number of shares they had before.

A public company is not required to issue dividends at all. However, it's not a good look for a company to abruptly stop paying or pay less in dividends than in the past.

For the company, a stock dividend is a pain-free way to issue dividends without depleting its cash reserves.

Journal Entries for Stock Dividends

When a stock dividend is issued, the total value of equity remains the same from the investor's and the company's perspectives.

All stock dividends require an accounting journal entry for the company issuing the dividend. This entry transfers the value of the issued stock from the retained earnings account to the paid-in capital account.

Small Stock Dividend Accounting

A stock dividend is considered small if the shares issued are less than 25% of the total value of shares outstanding before the dividend. A journal entry for a small stock dividend transfers the market value of the issued shares from retained earnings to paid-in capital.

Suppose Company X declares a 10% stock dividend on its 500,000 shares of common stock. Its common stock has a par value of $1 per share and a market price of $5 per share.

When the small stock dividend is declared, the market price of $5 per share is used to assign the value to the dividend as $250,000 — calculated by multiplying 500,000 x 10% x $5.

The common stock dividend distributable is $50,000 — calculated by multiplying 500,000 x 10% x $1 — since the common stock has a par value of $1 per share.

 Account  Debit  Credit
 Stock dividends  250,000  
 Common stock dividend distributable    50,000
 Paid-in capital in excess of par-common stock    200,000

When the company distributes the stock dividend, it can make the journal entry:

 Account Debit Credit
 Common stock dividend distributable  50,000  
 Common Stock    50,000

Large Stock Dividend Accounting

Large stock dividends occur when the new shares issued are more than 25% of the value of the total shares outstanding before the dividend. In this case, the journal entry transfers the par value of the issued shares from retained earnings to paid-in capital.

If Company X declares a 30% stock dividend instead of 10%, the value assigned to the dividend would be the par value of $1 per share, as it is considered a large stock dividend. This would make the following journal entry $150,000—calculated by multiplying 500,000 x 30% x $1—using the par value instead of the market price.

 Account Debit Credit
 Stock Dividends  150,000  
 Common stock dividend distributable    150,000

What Is an Example of a Stock Dividend?

If a company issues a 5% stock dividend, it would increase the number of shares by 5%, or one share for every 20 shares owned. If a company has one million shares outstanding, this would translate into an additional 50,000 shares. A shareholder with 100 shares in the company would receive five additional shares.

Why Do Companies Issue Stock Dividends?

Dividends, whether in cash or in stock, are the shareholders' cut of the company's profit. They also are a reward for holding the stock rather than selling it. A company may issue a stock dividend rather than cash if it doesn't want to deplete its cash reserves.

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

A stock dividend is paid out in the form of company shares. The stock dividend is not taxable until the shares are sold. A cash dividend is paid out as cash and is taxable for that year. The company will send you a 1099-DIV form at the end of the year.

Is a Stock Dividend a Good or Bad Thing?

Dividends are always good, whether they're in shares or cash. However, if you're buying dividend-paying stocks to create a regular source of income, you might prefer the money.

What Is a Good Dividend Yield?

A dividend-paying stock generally pays 2% to 5% annually, whether in cash or shares. When you look at a stock listing online, check the “dividend yield” line to determine what the company is paying out.

The Bottom Line

A stock dividend is a payment to shareholders made in additional shares instead of cash. The stock dividend rewards shareholders without reducing the company's cash balance. It has the adverse effect of diluting earnings per share.

Stock dividends may signal financial instability or at least limited cash reserves. For the investor, stock dividends offer no immediate payoff but may increase in value over time.

Article Sources
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  1. Internal Revenue Service. "Publication 550: Investment Income and Expenses." Page 22.

  2. Robinhood, "What Is a Stock Dividend?"

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