Stock Dividends and Stock Splits

For investors, it is important to understand stock dividends and stock splits. Stock dividend is different from stock split.  While it is true that, in both cases, new shares of stock are issued to current stockholders, distinction between the two has been recognized.  The distinctive difference between a stock dividend and a stock split is that in the former, there is a capitalization of earnings or profits, together with a distribution of the added shares which evidence the assets transferred to capital, while in the latter, there is a mere increase in the number of shares which evidence ownership without altering the amount of the capital, surplus or segregated earnings.

  In short, a stock split is but a dividing up of the outstanding shares of the corporation into a greater number of units without touching the stockholder’s original proportional participating interest in the corporation.  Stock split is basically one of form and not of substance.Concept of dividendsA stock corporation subsists to make a profit and to allot a percentage of the profits to its stockholders.

  The board of directors of a public corporation may declare dividends out of the unrestricted retained earnings which shall be payable either in cash, or in stock to all stockholders on the basis of outstanding shares held by them.  A dividend is that part or portion of the profits of a corporation set aside, declared and ordered by the directors to be paid ratably to the stockholders on demand or at a fixed time.

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  It is a payment to stockholders of a corporation as a return on their investment.  It is a feature of a dividend that all of the stockholders of the same class share in it in proportion to the respective amounts of stock which they hold.Without disturbing the capital stock, a dividend is an aggregate amount which can be shared among stockholders.  The term has been considered as suggesting that there must be a surplus or profits to be divided.  To warrant the declaration of dividends, there must be actual bona fide surplus profits or earnings over and above all debts and liabilities of the corporation.  Although a corporation has earned no profit from the current period, it may properly pay dividends from accumulated surplus out of previous years.  On the other hand, dividends may not be declared as long as a shortfall exists although; it has realized actual profit in the current year.Stock dividendsInstead of cash, a corporation may opt to declare stock dividend, which is a dividend payable in unissued or increased or additional shares.  Stock dividends do not decrease the value of the stockholder’s interest; they only bring down the cost per share of the stockholdings. To illustrate, Mr. X owned 200 shares of stock at $10 per share worth $2,000.  The company declared and distributed 25% stock dividend.  Mr. X would now own 250 shares for the same value of $2,000, with a new value per share of $8 (Heakal, 2003).  A corporation may increase its authorized capital stock by way of stock dividends without touching its unissued shares as long as there are retained earnings to justify the declaration.The declaration of stock dividend may be revoked at anytime before the actual issuance of the stock.  Unlike in cash dividend, a stock dividend requires, as a general rule, more than a mere declaration to make it effective.  It must be approved by the stockholders. Until the stock is actually issued, or at least in some manner especially set apart to the stockholders, its effect is not complete.  The so called stock dividend in shares of the kind already held gives the shareholder nothing in the way of a distribution of assets, but merely divides his existing shares into smaller units.  There is no increase in his proportionate claim upon the assets of the corporation or income by reason of such a paper dividend.  There is no obligation upon the corporation to declare stock dividends, which are not distributions but only a change of the share and capital structure.  Since the declaration of stock dividend gives the stockholder nothing until all the formalities necessary to a valid increase of stock are complied with, its revocation, therefore, takes away nothing.  But unless rescinded, the shareholders have absolute right to their respective shares in the stock dividend so declared and actual delivery of the corresponding certificate is not essential to make the shareholder the owner of the dividend (De Leon, l993).Dividends DatesEssentially, there are three dates to observe in dealing with dividends.  The first to consider is the date of declaration where the board declares dividend and sets the amount of dividend, the payment date and the ex-dividend date. Next is the record date, where all list of of current stockholders who are to receive dividends are rolled up. The most important date is the 2-day period before the record date which is designated as the ex-dividend date. This is to allow completion of all unfinished transactions before the record date.  Those stockholders not on record or do not own the stock before the ex-dividend date will not be entitled to dividend payment. Proceedings not completed at the ex-dividend date, the price of the stock is immediately reduced as dividend payment dilutes the value of the company and investors absorbs the diminution in value (“Investing”, 2007).Effect of declaration of stock dividendA stock dividend transfers the surplus covered by such dividend into permanent account thereby placing it beyond the power of the board of directors to withdraw from corporate use and to distribute to the stockholders.  Such a capitalization of surplus adds nothing to and takes nothing from the corporation.  The corporation merely transfers the surplus to capital account and issue shares of stock to represent the same.  Such shares may be preferred as well as common stock.After a declaration of stock dividends, the stockholder receives no greater proportional interest in the assets of the corporation that he had before.  In this regard, it is identical in substance with a splitting of original share in which outstanding shares are exchanged for an increased number of new shares of proportionally less par value than the old, leaving the aggregate value of all his stock substantially the same.  Such an increase simply dilutes the shares as they existed before.  The declaration of stock dividend is advantageous to existing creditors of the corporation to the extent that corporate earnings are capitalized, unavailable for distribution to stockholders.  At the same time, it improves the cash position of the corporation with expansion projects or programs eliminating the necessity of borrowing and paying high interest rates.Stock dividends are not taxable as income because they represent merely an unrealized gain to the stockholders who receives nothing from the corporation that answers the definition of income under the revenue code (“Strengthening”).Illustration:A, B, C, D and E organized a stock corporation with an authorized capital stock of $400,000 divided into 4,000 shares with a par value of $100 per share.  Each subscribed to and paid for 400 shares.  Hence, the actual asset of the corporation at the beginning of the business was $200,000.After a few years of profitable business, the assets of the corporation amounted to $400,000 with no debts.  Instead of declaring cash dividends, it was agreed to increase the capital stock in the form of stock dividends with a total value of $40,000 which amount represents the actual increase of his share or interest in the business.  At the start of the year, each stockholder held 400 shares with a total value of $40,000 which is 1/5 of the total corporate capital of $200,000.  At the close of the year, after stock dividends are declared, each stockholder still holds 1/5 interest in the corporation with his 800 shares worth $80,000 in relation to the increased corporate capital of $400,000.  But the proportional interest of each share in the corporate assets is decreased because of the increase in the number of shares, from 1/2,000 to 1/4,000 (Kennon, 2007).Stock dividend from issue of additional sharesWhenever an increase is made in the capital account of a stock corporation, the increase is valid only when it represents additional shares issued for which the equivalent consideration is received by the corporation.  The increase may be the result of an issue of additional shares or the re-investment of retained earnings effected by the distribution of shares as stock dividend.Hence, a corporation with outstanding no par value shares originally issued at $5 per share cannot increase its capital account by transferring its surplus to its capital account without issuing additional shares for the amount transferred.  Under such method, stockholders who have already paid in full their no par value shares would in effect be made to pay additional amounts for the same shares to increase their value.  No par value shares of capital stock issued shall be deemed fully paid and non-assessable.  Once no par value shares have been issued at their issued price, their value can no longer be changed.  Accordingly, such stock dividend by a transfer of the surplus to capital with no shares to be issued cannot be validly made (De Leon, 1993).Stock dividend distinguished from cash dividendStock dividend does not involve any disbursement to the stockholders of accumulated earnings, while cash dividend involves disbursement of said earnings.  Corporate creditors may reach for stock dividends, being still part of corporate property, while cash dividend declared and paid becomes the absolute property of the stockholders and cannot be reached by the creditors.  While corporate capital is increased by a stock dividend, cash dividend does not.  Except in the sense that capital stock constitute a liability, no debt from the corporation to the stockholders is created by the declaration of stock dividend.  The declaration of cash dividend creates an obligation to the stockholders who then hold such stock.It is important to note that a dividend payable in stock is not synonymous with, and is not always or necessarily, a stock dividend.  A dividend payable in stock may, under some circumstances, is a cash dividend, as where the dividend consists in treasury stocks or in stocks of another corporation.Stock splitsThe board of directors may approve a stock split when the market is too high or too low, as sometimes investors are forestalled from buying or keeping their stocks.  In stock split, the market per share is adjusted by the same ratio which results in additional shares being issued and the market price being reduced to a trading level to attract investors. Stock splits are generally carried out in two different ways.  In a par value stock, the original certificate is converted into a new certificate validating the original shares, plus the new shares issued.  In a no par value stock, the stockholder keeps his original certificate but receives additional certificates for the additional shares issued. In either case, the split merely changes the number of outstanding shares without affecting the stockholders’ equity or the capital stock (Heakal, 2003).Illustration:X Corporation has 100,000 outstanding shares of stock, with a par value of $10 per share.  The board of directors feels that a lower price is necessary to attract more investors, it authorized that the 100,000 shares be replaced by 500,000 with a par value of $2.  Thus each stockholder will receive 5 shares in exchange for each share owned.  This increase in the number of outstanding share is referred to as stock split (Little, 2007).On the other hand, the reverse stock split, involves the reduction of the outstanding shares into a smaller number of shares and it is done when it is felt that a higher price for the shares will be advantageous to the corporation.  Thus, in the same example above, the 100,000 outstanding shares may be called in and replaced by 50,000 shares with a par value of $20 per share.  There is an increase in the par value of outstanding shares with a corresponding reduction in the number of shares issued.If a stock splits, it does not make it a better investment or enlarges the share in the company’s earnings nor does it affect materially short sellers. The aim of stock splits is to lower the trading price of a stock to a level viewed as popular to investors. It is comfortable to purchase stock at $10 per share than at $100 per share. Hence, when share prices have moved up considerably, publicly-listed companies declare stock split.ConclusionOne way or another, the stock itself may change, whether it is a stock split or a stock dividend.  It is crucial that an investor must be fully aware of the character of corporate actions to understand how a corporate decision affects his interest in the business. Corporate action may bring a change in the stock (“Corporate”).Whether it is cash dividend or stock dividend, dividends matter. It is the evidence of profitability.  It offers unvarying return on a less secure investment. Dividends grow as the company grows thus providing more economic value to the investors. Some investors profit from dividends.  Investors would purchase stocks right after dividend is declared and sell it after collecting the dividend, thus, receiving dividend at no cost.  However, this does not usually happen successfully as the dividend payout reflects immediately the stock price.It is important that an investor understands stock splits.  Stock splits do not change the equity of the company or the net assets of the business.  Board of directors approves stock splits to maintain high level of trading activity of its stock. Sometimes a reverse stock split is decided to discourage small investors and maintain its status because a relatively low stock price is considered highly speculative and often trades over the counter.