What is a Stock Dividend?

A stock dividend is like your friend buying you lunch instead of paying you back with cash…

When you lend money to a friend, they might pay you back by buying you a meal or with another favor, rather than returning cash. When companies share their profits with shareholders, they often do so through cash dividends. But with stock dividends, the company instead pays its shareholders in the form of company stock.

While most companies choose to pay dividends to their shareholders in the form of cash, some pay in additional shares instead. Similar to a cash dividend, when a company declares a stock dividend, it specifies how many shares each owner will receive for each share they own. For example, instead of saying that each owner will receive $1 per share owned, the company will declare a dividend of 0.1 shares per share already owned (meaning someone who owns 10 shares in the company would receive one additional share.)

Dividends stocks are shares of companies that pay dividends to their shareholders. Typically, companies pay dividends in cash, but they can also pay dividends in the form of stock (additional shares in the company) or other valuable property. Stock dividends work almost identically to cash dividends. The primary difference is that instead of shareholders receiving cash, they receive more stock.

When a company wants to pay a dividend (whether cash or stock), it declares the dividend, a record date, and a payable date. The company specifies the amount that it will pay to each shareholder. For example, a business could declare a dividend of, say, $2 per share in cash, or 0.15 shares per share owned. The company also specifies a date by which someone must own company shares in order to receive a dividend (aka ex-dividend date). If someone buys stock in a company that plans to pay a dividend, and makes their purchase on or after the ex-dividend date, they won’t receive the dividend payment. The person who sold the shares will receive the dividend instead.

For example, let’s say the ex-dividend date for the fictional Super Skate Parks Inc.’s next dividend is July 9th. You would need to buy shares on or before July 8th to receive a dividend payment.

The ex-dividend date is determined by the record date the company set and the stock exchange’s rules. Typically, it’s one business day before the record date. On the payable date, the company makes the dividend payout to the people who owned shares before, or on, the ex-dividend date.

One possible advantage to receiving a stock dividend is that it may function like an automatic reinvestment (You wouldn’t have to pay commission on a new purchase, and you might pursue compounding returns, as your shares earn more shares).

On the other hand, a drawback of stock dividends is that they don’t provide immediate cash flow to investors. Many investors view dividend-paying stocks as a source of income, especially in retirement. If a company pays its dividends in the form of shares rather than cash, it adds extra steps to the process for people who want to use their portfolio for cash flow.

Stock dividends may also offer less flexibility compared to its cash counterpart. If a company pays dividends to shareholders in cash, those investors can choose to buy more stock, or use the money in other ways, like funding other investments or expenses.

With a cash dividend, companies send money to shareholders based on the number of shares each person owns. For example, if a company declares a dividend of $0.25 per share, someone who owns 100 shares would receive $25. Companies pay these cash dividends out of their cash accounts, reducing the amount of cash on the company’s balance sheet.

Companies pay stock dividends by giving shareholders additional shares in the company. Rather than paying out cash the company has on hand, it creates and issues additional shares, increasing the number of shares that exist in the business. After a stock dividend is paid out, the number of overall shares goes up, with each share representing a smaller ownership stake in the company. Each shareholder’s stake remains the same.

Typically, both types of dividends lead to a decrease in a company’s share price. Cash dividends reduce the cash balance of the company, which reduces each share’s value. Stock dividends decrease how much ownership in the company each share represents, making each share less valuable. Usually, the cash received or additional shares owned make up for the reduction in stock price.

Stock dividends and stock splits are similar in that both increase the number of shares that each shareholder owns. That said, there are slight differences.

A stock split divides the number of existing shares. It doesn’t require that the company splitting its stock have additional authorized shares available and doesn't require the same accounting that a stock dividend does.

A stock dividend sends additional shares to a company’s owners out of its pool of non-issued shares. The company has to record stock dividends differently from a stock split, namely by reducing retained earnings (money the company keeps instead of paying out to investors).

Both stock splits and stock dividends lead to similar results — They reduce a company’s per-share price without significantly impacting its market capitalization (overall value), and increase the number of shares that each shareholder owns.

You only need to own a stock for one day to receive a dividend, but the day on which you own the stock is important. When a company declares a dividend, it specifies the size of the dividend, the dividend’s record date (when someone must be the shareholder on record to get a dividend), and the payable date. Based on stock exchange rules, the company sets an ex-dividend date (the day on which you had to own a stock to get the dividend) based on the dividend record date. Typically, the ex-dividend date is the business day before the record day.

If you own a dividend-paying stock when trading opens on its ex-dividend day, you're likely to receive the dividend. If you sell the share on or after its ex-dividend date, you'll still receive the dividend, even though you no longer own the stock. By the same token, you won’t receive a payment if you buy a share on or after the ex-dividend date.

There's an advantage to holding certain dividend-paying stocks for more than a day — You pay taxes on qualified dividends at the long-term capital gains tax rate rather than the standard income tax rate. In other words, you pay less tax on qualified dividends.

For a dividend to be “qualified,” it must meet the following criteria:

• The dividends must have been paid by an US corporation or a qualified foreign corporation.
• The shareholder must have held the shares for at least sixty-one days in the 120-day period, beginning 60 days before the ex-dividend date. Preferred stocks have a longer holding period.

When a company issues a stock dividend, it increases the number of shares outstanding in the company. This dilutes the value of each share (aka stock dilution). Stock dilution happens when a company changes the number of shares issued and diminishes the percentage of the company that each share represents. For example, let’s say the fictional company American Landscaping has 100 shares outstanding (held by the public), meaning each share in the company represents a 1% ownership. If the company issues a stock dividend that expands the number of shares outstanding to 125, each share now represents .8% ownership in the firm.

Stock dividends and splits dilute the value of each share, but leave shareholders with the same overall ownership stake.

Dividend yield measures the amount that shareholders receive in dividends compared to the price of a single share. Typically, investors look at dividend yield for companies that pay cash dividends.

The formula for calculating dividend yield is:

Annual dividend / current stock price = dividend yield

Dividend yield changes on a day-to-day (and even minute-to-minute) basis. Whenever a company’s stock price changes, the payout ratio (ratio of dividend payments to total earnings) changes.

Some investors who want to produce a cash flow from their investments look for dividend yield when selecting shares to buy. However, some high-yield stocks (those that pay high dividends compared to their stock price) may indicate an unhealthy company, depending on the situation. For example, a company might not be able to sustain the dividend over the long term, or its share price may have taken a large hit recently. If the business is performing poorly and losing value, it might earn enough revenue to pay its promised dividend. If the dividend proves unsustainable, the company could reduce the dividend without warning.

Some investors use tools like stock screening software to look for companies that meet certain criteria. For example, an investor could look for dividend stocks based on their dividend yield or only look for dividend-paying companies that have a minimum market capitalization (total value).

If you need help coming up with a dividend-focused investing strategy, you may want to consider working with a professional advisor to help you devise a plan. As with any investment-related decision, it’s important to do your research ahead of time.

When you open a brokerage account, you can place orders to buy shares. Another option may be to invest in exchange traded funds (ETFs) and mutual funds that focus on dividend-paying companies. Such funds let you buy shares in one fund to diversify your investment across multiple companies. Before making any investment, it’s important to research and understand the potential gains and risks involved.

Disclosure: Dividends are not guaranteed and may be reduced or eliminated by the issuing company.