# Understanding Stock Dividends: Definition, Examples, and Benefits

> **Definition**
>
> A stock dividend is a payment to shareholders in the form of additional shares in the company rather than cash. This dilutes the share price but allows the company to preserve its cash reserves.

## What Is a Stock Dividend?

A stock dividend is a payment to shareholders of additional shares of a company's stock. It differs from cash dividends paid to shareholders because the payment doesn't consist of cash. To preserve its cash, a company may decide to pay dividends in stock. Distributions are paid in fractions per existing share. So, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. That means that the owner of 100 shares would get five additional shares. Stock dividends aren't taxed until the shareholder sells their shares. In addition, stock dividends don't affect the value of the company. However, stock dividends can dilute the stock's share price in the short term because additional shares (or fractions thereof) have been issued.  

### Key Takeaways

*   Stock dividends are not immediately taxable, allowing investors to defer taxes until they sell the shares, which can provide a significant tax advantage compared to cash dividends.
*   One of the primary reasons companies issue stock dividends is to conserve cash while still rewarding shareholders, making them an attractive option during periods of limited cash reserves.
*   While stock dividends dilute the share value in the short term, they can lead to increased investor interest due to the reduced share price.
*   The process of issuing stock dividends can either involve small shares that account for less than 25% of the existing shares or large shares that exceed this threshold, each requiring different accounting treatments.
*   Although stock dividends do not reduce a company's cash reserves, they can suggest limited cash availability, potentially signaling financial instability.

![Stock Dividend](https://www.investopedia.com/thmb/NsWlBuhFE1vQONmp43rCTi2mMhA=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Term-Definitions_stockdividend-Final-d94fb4a398d94fa4805cba1e9c14b124.jpg)

*— Investopedia / Jessica Olah*

## Understanding the Mechanics of Stock Dividends

Companies might pay a stock dividend to reward investors without using cash, saving the latter for other needs. The stock dividend has the advantage of rewarding shareholders without reducing the company's cash balance. However, it does increase its liabilities.

Stock dividends offer a tax advantage; they are not taxable 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](https://www.investopedia.com/terms/h/holdingperiod.asp) typically begins the day after the dividend is received.

## How Stock Dividends Cause Dilution

Issuing more stock leads to dilution, reducing [earnings per share](https://www.investopedia.com/terms/e/eps.asp) and each shareholder's ownership percentage.

Dilution is a downside if the company's net income doesn't increase accordingly.

### 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.

### Pros and Cons for Companies and Investors

Pros

*   The company rewards investors while keeping its cash
    
*   The decrease in share price may attract new investors
    
*   Investors do not owe tax on these dividends until the stock is sold
    

Cons

*   Bonus shares dilute the share price
    
*   Stock dividends may signal a company's financial instability
    
*   Share dividends are less attractive than cash dividends to some shareholders
    

## Pros and Cons of Receiving 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.

Stock dividends lower the share price in the short-term, attracting more buyers. Shareholders may benefit later as their investment grows in value, or sell the new shares for cash while keeping their original amount.

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.

A stock dividend lets a company reward shareholders without using its cash reserves.

## Accounting Entries When Issuing 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.

Companies must record stock dividends with accounting journal entries, transferring value from retained earnings to [paid-in capital](https://www.investopedia.com/terms/p/paidincapital.asp).

### Accounting for Small Stock Dividends

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:

### Accounting for Large Stock Dividends

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](https://www.investopedia.com/terms/p/parvalue.asp) of the issued shares from retained earnings to paid-in capital.

If Company X declares a 30% stock dividend, it's valued at $1 per share and considered large.

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.  

## What Is an Example of a Stock Dividend?

If a company issues a 5% stock dividend, it would increase its number of outstanding shares by 5%, or one share for every 20 shares owned. If a company has one million shares outstanding, this would translate into an additional 50,000 shares. A shareholder with 100 shares in the company would receive five additional shares.

## Why Do Companies Issue Stock Dividends?

Dividends, whether in cash or in stock, are the shareholders' cut of the company's profit. They also are a reward for holding the stock rather than selling it. A company may issue a stock dividend rather than cash if it doesn't want to deplete its cash reserves.

## What Is the Difference Between a Stock Dividend and a Cash Dividend?

A stock dividend is paid out in the form of company shares. The stock dividend is not taxable until the shares are sold. A cash dividend is paid out as cash and is taxable for that year. The company will send you a 1099-DIV form at the end of the year.

## Is a Stock Dividend a Good or Bad Thing?

Dividends are always good, whether they're in shares or cash. However, if you're buying dividend-paying stocks to create a regular source of income, you might prefer cash.

## What Is a Good Dividend Yield?

A dividend-paying stock generally pays 2% to 5% annually, whether in cash or shares. When you look at a stock listing online, check the “dividend yield” line to determine what the company has been paying out.

## The Bottom Line

Stock dividends reward shareholders with additional shares while preserving a company's cash reserves. Stock dividends can dilute earnings per share temporarily but they do not inherently change a company's overall value. In addition, a lower share price in the short term can attract new investors. Stock dividends' tax advantage for investors is that they aren't taxable until the shares are sold. For companies, the trade-off is that some investors might prefer cash dividends for immediate income, but others may appreciate the potential for growth in the value of their investment.  

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Publication 550: Investment Income and Expenses](https://www.irs.gov/pub/irs-pdf/p550.pdf)." Page 22.