Management Notes

Reference Notes for Management

Stock Dividend – Why do companies give stock dividends? | Financial Management

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

You May also like:

 

Play Quiz

[wp_quiz id=”6809″]

Smirti

Leave a Comment