Stock Dividend | Why do companies give stock dividends? | Financial Management | Management Notes
What is a stock dividend ?
Companies do pay dividend to its existing shareholders in the form of cash or additional shares of common stock or both. When the companies pay dividends to its existing shareholders in the form of additional shares of common stock then it is referred as Stock Dividend.
Why does a company issue Stock Dividends?
Stock Dividends are issued by the companies rather than issuing cash dividends in order to preserve the cash for other attractive investment opportunities (projects). When the company issues cash dividends, Cash Outflow occurs from the company because shareholders are distributed cash in the form of dividends from the Retained Earnings (R/E) balance of the company.
But, when the company issues Stock Dividend, cash outflow does not occurs in the company because it simply represents recapitalization of a company where certain amount of balance from the Retained Earnings (R/E) is transferred to Paid – in – Capital and Common Stock Account. This clearly indicates that shareholders’ position in the company will remain unchanged.
When the company issues Stock Dividend, it is obvious that the number of outstanding shares in the market increases those results in following scenarios:
- It decreases the Earnings Per Share (EPS) and Market Price Per Share (MPS).
Note: Although, issuing Stock Dividend proportionately decreases the EPS, it does not affect the total earnings available to its common stockholders.
Stock Dividend Example: [ XXX Company ]
Let’s take an example to illustrate the effect of Stock Dividend and justify the above mentioned points.
XXX Company Total Shareholder’s Equity Account [Before Announcing 20% Stock Dividend] |
|
Particulars | Amount in Rs |
Common Stock [200,000 Shares @ Rs 100 Par Value] | 20,000,000 |
Additional Paid in Capital | 1,000,000 |
Retained Earnings | 24,000,000 |
Total Shareholder’s Equity | 45,000,000 |
Let us assume that XXX Company announces 20% Stock Dividends. After this announcement,
- XXX Company need to issue additional 40,000 Shares [20% * 200,000 Shares] of Common Stock.
- Let us assume that the current Market Price of Stock is Rs 400. This means that the total amount of Stock Dividend that is to be paid is Rs 16,000,000 [ Additional 40,000 Shares * @ Current Market Price Rs 400 ]
- The total amount of Stock Dividend i.e. Rs 16,000,000 will be transferred from the Retained Earnings (R/E) Account to the Common Stock Account and Additional Paid-in-Capital.
Since, the Par Value of the Common Stock is Rs 100,
- Total Amount Transferred to Common Stock Account is Rs 4,000,000 [40,000 Shares* @100 ]
- Total Amount Transferred to Additional Paid-In-Capital is Rs 12,000,000 [40,000 Shares* @300 ]
XXX Company Revised Total Shareholder’s Equity Account [After Announcing 20% Stock Dividend] |
|
Particulars | Amount in Rs |
Common Stock [200,000 Shares @ Rs 100 Par Value]
Add: Additional Shares [40,000 Shares* @100 ] Total Common Stock |
20,000,000
4,000,000 24,000,000 |
Additional Paid in Capital
Add: [40,000 Shares* @300 ] Total Additional Paid in Capital |
1,000,000
12,000,000 13,000,000 |
Retained Earnings
Less: [40,000 Shares * @ Current Market Price Rs 400 ] Total Retained Earnings |
24,000,000
16,000,000 8,000,000 |
Total Shareholder’s Equity | 45,000,000 |
Example: Effect of Stock Dividend on Earning Per Share (EPS) and Market Price per Share (MPS).
Effect on EPS
Suppose, XXX Company has
- Net Income = Rs 6,000,000 [After Interest and Tax]
Then, Earnings per Share (EPS) = Net Income / Number of Shares Outstanding
= Rs 6,000,000 / 200,000 Shares
= Rs 30
After 20% Stock Dividend,
Earnings per Share (EPS) = Net Income / Number of Shares Outstanding
= Rs 6,000,000 / 240,000 Shares
= Rs 25
Effect on MPS
Suppose, XXX Company has
- Before 20% Stock Dividend , Market Price of Stock (MPB) = Rs 400
- Number of Outstanding Shares before 20% Stock Dividend (SB)= 200,000 Shares
- Number of Outstanding Shares after 20% Stock Dividend (SA) = 240,000 Shares
After 20% Stock Dividend,
Market Price of Stock (MPA) = ( MPB * SB ) / SA
= (Rs 400 * 200,000)/ 240,000
= Rs 333.33
Findings |
||
Particulars | Before 20% Stock Dividend | After 20% Stock Dividend |
Earnings Per Share (EPS) | Rs 30 | Rs 25 |
Market Price Per Share (MPS) | Rs 400 | Rs 333.33 |
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