Many investors buy stocks with cash dividends so they can receive a return while they wait for the shares of the stock to appreciate. Stock dividends are totally different. They do not provide an investor with an extra return. An impact on shareholder's equity occurs, but it does not increase the account.
Shareholder's equity is a section of the balance sheet and describes the capital contributed to the company by shareholders. It is one-third of the basic formula "assets equal liabilities plus shareholder's equity." The shareholder's equity is made up of a number of different accounts, including retained earnings, paid in capital and additional paid in capital. The easiest way to calculate shareholder's equity is subtracting liabilities from assets. For example, a company has $50 million in assets and $25 million in liabilities. To find the value of shareholder's equity, subtract $25 million from $50 million. The answer is that the company's shareholder's equity has a value of $25 million.
Dividends are payments made by a company to shareholders. The most common type of dividends are regular dividends. Regular dividends are payments to shareholders on a recurring basis. A company may pay dividends to shareholders on a monthly, quarterly, semi-annual or annual basis. Stock dividends are additional shares that a company gives to shareholders. This does not involve cash payments. For example, a company may announce a stock dividend of five shares for every 10 shares owned.
Stock Dividends & Shareholder's Equity
Stock dividends are simply a shift of money from the retained earnings account in shareholder's equity into the contributed capital account in shareholder's equity. There is no net overall impact on shareholder's equity. The balance shifted over is determined by the value of the shares on the day of the stock dividend. For example, a company issues a 10 percent stock dividend and the price of the shares on the day is $10. This move will increase the number of shares outstanding in the company by 10 shares. It had 100 shares outstanding. Retained earnings will decrease by $100, and paid-in capital will decrease by $100. The result of $100 is calculated by multiplying the new number of shares of 10 by the price of $10 a share.
A stock dividend does not have an impact on the value of the company or the value of your holdings. The stock dividend will simply give you more shares at a lower price. The reasons a company may want to offer a stock dividend are numerous, including a preference that its shares trade at a lower price and be perceived cheaper by the market.