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

What Is a Stock Dividend?

A stock dividend is a payment to shareholders that consists of additional shares of a company's stock 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.

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. Unlike cash dividends, 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

When a company issues additional stock shares for any reason, the result is stock dilution. More shares in circulation means a reduction in the earnings per share (EPS) of the existing shares, and in the ownership percentage held by each current shareholder.

Dilution is a downside of a stock dividend if the company's net income does not increase proportionately.

Example of Stock Dividend Dilution

An example of share dilution is as follows:

• Before dilution: If a company has one 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.

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. Or, 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 on common stock. However, it's not a good look for a company to abruptly stop paying dividends 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.

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

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.

The Bottom Line

A stock dividend is a reward for 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, at least temporarily.

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. Of course, the investor can simply sell the extra shares and collect the cash.