If you idolize Warren Buffet and wish to be as successful as he is, you must learn all you can about investing. The billionaire’s portfolio comprises stocks of reputable companies, but for him to acquire such massive success, he had to do his homework. Since the aim of investing is to get a share of the profits, you might as well learn how you will be compensated for having a stake in your chosen company. While most people think that cash is the only way to receive dividends, you will be surprised to learn that you can also be paid in the form of shares. So, let’s get right into every detail regarding the distribution of a stock dividend and help you become an informed investor.
Process of stock dividend distribution
Corporate Finance Institute explains that the stock dividend is a method of wealth distribution among a company’s existing shareholders in which dividend payments are made in the form of stock instead of cash. It is usually up to the board of directors (BOD) to determine the type of dividend the shareholders will receive, and when to declare the dividend. The date on which the company’s BOD decides on payment of the dividend is the date of declaration. As a result of this declaration, journal entries must be made to reflect what the company owes its shareholders; therefore, retained earnings are debited while the stock dividend distributable is credited. However, you must note the dividends are paid only on outstanding shares.
After the date of declaration is set, the date of record is determined to show that shareholders who held stock on that particular day will qualify for dividends. Consequently, the first day on which an investor is not eligible for receiving dividends is also set and is known as the ex-dividend date; it is usually the day after the date of record. There are no journal entries for these dates since no transaction has taken place. The market share price usually drops on the ex-dividend date by the amount of the dividend.
Next comes the date of distribution /payment on which the shareholders are paid their dues; it usually happens about a month after the record date. As a result, journal entries are made to show the transaction such that the stock dividend distributable is debited while common stock is credited. If it was a small stock dividend( less than 20-25% of the outstanding shares), any amount above the stock dividends distributable over the credited amount to common stock is credited to additional paid-in capital.
For most companies, they prefer to grow without increasing their liabilities; hence, they need to conserve their cash for expansion purposes. Since they can still want to retain their shareholders by paying dividends, yet money is out of the question, the stock dividend provides an alternative. Sometimes, companies may not be looking to expand their operations, but they are not doing well; hence cannot afford to pay cash dividends.
Increase share liquidity
Companies issue more shares without increasing their value; hence the shares are sold at reduced prices. As a result, the liquidity of the shares is increased.
Expect more profits
Stock dividends increase a company’s outstanding shares; therefore, its value is not increased. The dividends do not affect the net assets but instead decrease retained earnings with the same amount with which they raise the paid-up capital. For a company to offer a stock dividend that reduces its retained earnings, it means that it is foreseeing a more profitable future so that the increase in retained earnings will offset the additional outstanding shares.
- Make the shares more affordable
- Any buyer interested in stock dividends will get the shares at a price lower than the market value. As a result, the company’s shares are more affordable to the public.
- How investors benefit from stock dividend distribution
- No tax liability.
Once you receive cash dividends, you are taxed because they are treated as income. However, Dividend Investor informs us that stock dividends do not attract any tax liability upon their receipt. However, should you choose to sell them, then your profit will be treated as a capital gain, which is still taxed at a much lower rate than the income tax rate on cash dividend distributions.
How often are the stock dividends distributed?
Regardless of whether the company offers a stock dividend or cash dividend, the frequency with which it decides to pay its shareholders is dependent on the company. As Dividend.com explains, there are no set rules regarding the distribution of dividends. Therefore you will find that some companies pay monthly, quarterly, semiannually, annually, and even irregularly. However, in the US, since companies must report their financial earnings quarterly, most companies schedule their dividend payments to coincide with such reporting calendars. It is therefore advisable that if you are looking for dividend payouts as your regular source of income, you should do your homework and determine how often a company pays.
How long you need to own stock to qualify for stock dividends
You do not need to have owned stock of a company for ages to be entitled to the dividend payouts. If you buy stock two business days before the next dividend payout, you qualify for the dividend. However, before you think of engaging in such trades such that you wait until a company is about to declare dividends to buy stock then later sell, you should know that you will end up losing. Your broker will benefit because you will have paid their fees, but you may barely break even as the investor. Usually, after the dividend is paid out, the price of the stock falls by the corresponding amount. The market adjusts itself to account for the revenue deducted from the books. This effect beats the purpose of holding shares short term.