What Is the Effect of a Declared and Issued Stock Dividend ?

by Chirantan Basu

    Dividends to shareholders are usually in the form of quarterly cash distributions from after-tax earnings. However, some companies may choose to pay dividends in stock, while others give investors the option of receiving their dividends in cash or stock. These stock dividends may also be the result of restructuring activities, such as spinning off a subsidiary as a separate publicly-traded company. Companies can reinvest the cash earnings and investors can keep or sell the dividend shares.

    A company's board must authorize a cash or stock dividend. The company then issues a press release communicating the record date and the payment or issue date. The record date is the last date for shareholders to be on the company's books if they wish to receive the dividend. The ex-dividend date is the first date the stock trades without the seller having to deliver the stock dividend to the buyer. This ex-dividend date is usually set one business day after the stock dividend is paid. Companies usually express stock dividends as percentages of existing shares. For example, a 10 percent stock dividend means one new share for every 10 shares in a portfolio.

    The announcement of a cash or stock dividend, especially if it is a company's first such declaration, can result in a short-term price rally as investors are attracted to the prospects of regular cash income or equity ownership. However, the long-term performance of the shares would depend on fundamental financial measures, such as sales and earnings growth. Stock dividends increase the number of issued shares for companies and the number of shares held for investors, without increasing the total value of these shares. For example, an investor holding 100 shares will hold 110 shares after a 10 percent stock dividend. However, the total value of these shares will not change because the price of the shares would drop by about 10 percent.

    As of this publication, stock dividends are not taxable and investors do not have to report them on their annual tax filings to the Internal Revenue Service. This tax treatment is different from regular cash dividends, which are taxed as income or as capital gains when held outside of tax-sheltered accounts. Stock dividends give investors the flexibility of reinvesting in companies without incurring transaction costs and tax liabilities. Investors can also sell the shares later and reinvest the cash in other investments.

    Stock dividends are similar to stock splits in that both increase the number of shares without increasing the value of shares held. However, stock splits usually serve a different purpose. Companies with high share prices may split their shares to make them more affordable for retail investors. For example, a share trading at $20 will trade at about $10 after a two-for-one stock split, but the total number of shares will double.

    About the Author

    Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.

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