Stock Dividend vs. Stock Split

Published by Alex on

Stock dividends and stock splits are two terms that are generally used interchangeably when they shouldn’t be. The two terms may be similar, but there are differences between them. The critical difference between stock dividend vs. stock split is that while stock dividends allocate shares free of charge to current investors based on their existing investment, a stock split divides existing shares into multiple units to expand the number of shares.

Stock Dividends

A stock dividend is one of the two ways in which a company grants dividends to shareholders. Companies can also issue cash dividends to investors. While cash dividends are the most common method to reward shareholders, some companies choose to offer stock dividends. These dividends are handy when the company doesn’t make enough profit to cover cash dividends. Investors are awarded more shares based on how many shares they already own. Given that no money exchanges hands, the shares’ total value remains the same after the stock dividend.

Suppose Company A offers a stock dividend where shareholders get one additional share per 25 shares they hold. Investor A has 150 shares in the company, so the company awards them six additional shares.

There are two varieties of stock dividend; a small stock dividend and a large stock dividend.

A small stock dividend happens if the shares issued are less than a quarter of the shares outstanding before the dividend. A large dividend is when the number of shares issued is more than 25% of the total number of shares outstanding before the dividend.

Stock Splits

A stock split is when a company divides existing shares into several units. By doing this, a company increases the total number of outstanding shares without adjusting the full value of those shares as the split doesn’t take cash into consideration.

For example, Company A has a total market value of $3 billion spread across 30 million shares worth $100 each. The company implements a stock split on a three-to-one basis. The total number of shares increases to 60 million after the split. The split also causes the shares to be worth $50, meaning that the total $3 billion is still accurate.

The advantage of using a stock split is to improve share liquidity. Shares become more affordable to investors after a split because they go down in price. Stock splits are primarily done by large corporations such as PepsiCo and Wal-Mart.

Companies typically split stocks when share prices are rising. However, splitting at the wrong time due to overconfidence can cause problems if the share price drops below certain thresholds in the future. The decision to split the stock should be carried out by the board of directors or by a committee vote with shareholders. As such, the decision to split the shares is a costly and time-consuming exercise.

A “Reverse Stock Split” happens where the number of shares is reduced by merging shares.

Difference Between Stock Dividend & Stock Split

There are a few key differences between the two terms.

  1. A stock dividend is a form of a dividend where a company pays shareholders with additional shares. A stock split is when existing shares are divided, so everyone has more individual shares but without adjusting the total value.
  2. The shares from a stock dividend are new shares offered to exist shareholders. A stock split is when existing shares are divided into more shares. Thus, there are no new shares allocated in the process.
  3. A stock dividend is typically done to pay due dividends when a company doesn’t have the cash flow necessary to make cash payments. A stock split is done to reduce individual shares’ market value to make them more accessible and affordable.
  4. Stock dividends are recorded in a Journal Entry with companies debiting the Reserves and crediting Issued Share Capital. No Journal Entry is needed for a stock split. Any changes are made to Issued Share Capital.
  5. Existing shareholders are given new shares with a stock dividend, whereas a stock share sees existing shares divided.

What is Better?

A stock split is better for a small investor who can’t afford expensive stocks, such as stocks in Amazon and Google. If you only have a few hundred dollars to invest, you couldn’t buy even one share in such big companies. This is why a stock split would be great for you. The process reduces the prices for shares, meaning that even bigger investors without much money have a greater variety of stocks to invest in.

Stock dividends are also good and are a reason to invest in certain companies. However, beginner traders are likely to emphasize the value of the dividends they receive than the future prospects of a company or other factors like that. Dividends are often crucial for people who are investing to make money. If you have a lot of money invested into a stock or are retired and aren’t interested in selling stocks or re-investing money, then it’s better to have dividends. This way, you get your money without any issues.

Other investors would prefer if companies had the extra money. Companies could invest the money in growing the business, creating new products and services, improving current offerings, and doing similar things rather than paying shareholders. A company re-investing in itself means that the investor gains more over time as the share price goes up.

Which one is better for you as an investor depends on your approach to investing.

Final Thoughts

Both a stock dividend and a stock share lead to more total outstanding shares. The main differences are the reasons for the action and the method of increasing shares. A stock dividend is when people are allocated new shares based on their existing holdings. Dividends are used as an alternative to cash dividends. Stock splits divide existing shares to reduce their value. Splits are done to make individual stocks more affordable and increase the total share count.

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