A Guide to Stock Dividend

During your investment journey in stock markets, you must have often heard the term: stock dividends. But did you know the definition, features and benefits of this key term? Here’s everything you wanted to know about stock dividends.

Before understanding stock dividends, you must know about dividends. Any company, listed on the stock exchange, rewards its shareholders through dividends. Dividend payments are contingent upon the net profit being made by the company. The board of directors of a company decide the terms of dividend issuance, which, in turn, has to be approved by the key shareholders. Again the company can decide to pay a dividend in various forms such as cash, assets or stocks.

When the company makes dividend payments to its shareholders in the form of additional shares – instead of cash payment – it is known as stock dividend or stock bonus. Here, you must remember that the additional stocks have to be less than 25% of the company’s previously issued stocks. If the company issues more than 25% additional stocks, then it classifies as a stock split. The stock dividend payment can be made when the company does not have sufficient cash to make dividend payments in cash, or it wants to preserve its cash for other investment purposes.

Stock dividend example : To help you understand better about such dividend payments, here is a stock dividend example. Suppose ABC company with 10 lakh shares in the market issues 5% stock dividends, then it implies an additional issuance of 50,000 stocks. If D owned 100 shares of XYZ company then D would receive 5 additional shares. Usually, stock dividends in India are paid to shareholders on a pro-rata basis. Here is another stock dividend example for pro-rata stock bonus payment: Suppose XYZ company issues stock dividends on a 1:5 basis, it means that each shareholder will receive additional 5 shares.

Impact of dividend stocks on individual shareholders and market capitalisation of the issuing company: Issuance of dividend stocks does not increase the wealth of existing shareholders, nor does it increase the market value of the publicly traded company’s outstanding shares (market capitalisation). For individual shareholders, although the number of stocks being owned increases, there is also a corresponding decrease in the price of each share. This is because the market capitalisation of the company has not increased.

Let’s understand the scenario with another stock dividend example. Suppose G is a shareholder of LMN company and owns 1,000 shares, with the market price of Rs 10 per share. If the company announces a 10% stock dividend, he will now have 100 additional shares. Meanwhile, the market capitalisation of LMN company is Rs 10 lakh with 1 lakh outstanding shares. After announcing the stock dividend the total number of shares will increase to 1.10 lakh, while the stock price will decrease to Rs 9.09 (Rs 1,00,000/Rs 1,10,000=Rs 9.09).You can refer to the chart given below :

Shareholder G Before dividend After 10% stock dividend
Shares owned 1,000 1,100
Price per share Rs 10 Rs 9.09
Total value of shares Rs 10,000 Rs 10,000

Meanwhile, for LMN company

LMN Company Before issuing dividend stocks After issuing 10% dividend stocks
Outstanding stocks 1,oo,ooo 1,10,000
Price per share Rs 10 Rs 9.09
Market capitalisation Rs 10,00,000 Rs 10,00,000

Thus, from the above-mentioned example you can see that issuance of dividend stocks doesn’t impact the total value of shares being held by shareholders as market capitalisation of the issuing company remains the same.

Benefits of issuing dividend stocks :

Here is a look at the advantages of stock dividend payments:

  1. Allows the company to maintain its cash reserve : The foremost benefit of issuing dividend stocks is that it can allow the company to maintain its existing cash reserve. As this type of dividend payment requires zero cash transactions, the company can use its current reserve of cash for investment and business purposes.
  2. Tax implications for issuing dividend stocks: For individual shareholders, stock dividends involve zero tax consideration at the time of receiving the additional stocks. There are tax implications – either as short-term capital gains tax or long-term capital gains tax – only when such stocks are subsequently sold for a profit. Conversely, cash dividends have tax implications. According to the Finance Act, 2020, the dividend income is payable by the shareholders as per the applicable slab rates.
  3. Makes the stocks more affordable for common investors : Once the company announces dividend stocks, it results in a decrease in the market value of shares. This can make the stocks more affordable to common investors, thereby encouraging them to purchase such stocks. In other words, it can allow the company to maintain an investable price range.

Disadvantages of issuing dividend stocks:

The issuance of dividend stocks can also have some negative impacts. Here’s a look :

  1. Wrong signal of the company being in financial duress: If a company announces issuance of dividend stocks, then market participants might wrongly perceive it as the company facing difficulties in having an adequate cash reserve. While from the company’s standpoint, there could be multiple reasons justifying the issuance of dividend stocks, such an issuance can be incorrectly interpreted. This, in turn, can have an adverse impact on the company’s stock prices.
  2. Misinterpreting dividend stock issuance as a signal for the company’s investment in risky projects: There can also be a likely scenario of the market participants wrongly perceiving the issuance of dividend stocks as the company using its cash reserve for investing in speculative business ventures. This can negatively impact its stock prices.

Conclusion :

Thus, dividend stocks are additional shares issued to existing shareholders as a reward. This type of dividend payment has its unique features and benefits along with some disadvantages. Now that you know about stock dividends, make your investment journey in stock markets hassle-free by selecting a trusted and reliable financial partner. Look for features such as cutting-edge digital trading platforms, lifetime free Demat account and comprehensive market research reports.