DJ Stockbridge is currently pursuing a Masters degree in Accounting.
Scrip Dividend or Stock Dividend?
You are sitting at the dining room table having dinner with your parents, Doug and Ann. Both are business people. In fact, they run a publicly-traded company that is based out of your home town. The company has been doing well. They even started to pay cash dividends last year, and they want to try something new to reward the shareholders this year. There are two proposals, in particular, that are being debated: should the company adopt a scrip dividend or issue a stock dividend?
Let's explore both concepts further. In this lesson, we will give the definitions for both a scrip dividend and a stock dividend. We'll then walk through an example of each using hypothetical numbers from the publicly traded company your parents run. We will call the company Undecided Inc.
A scrip dividend program is when a company offers shareholders an option to receive dividends in two different forms: cash or additional company stock. A stock dividend is a little different. Instead of giving cash, or even the option of cash or shares, the company just gives the shareholders additional shares. So there is no option, like with a scrip dividend, and no cash, like with a cash dividend. There are just additional shares.
Let's go through two scenarios: Scenario 1 - Undecided Inc. offers a Scrip dividend and 50% of the shareholders elect to receive additional shares, and Scenario 2 - the company pays a stock dividend. Let's assume that Undecided Inc.'s current market price is $50. There are 1,000 shares outstanding. The market capitalization of Undecided Inc. is then $50 x 1,000 shares = $50,000. And the company pays a dividend once per year of $3.00 per share.
- Scrip dividend: The company will pay out $3.00/share x 500 shares = $1,500. They will then issue additional shares for the remaining 50% of the shareholders. They need to issue $1,500 / $50 = 30 additional shares. The new total number of shares outstanding is then 1,030 and the market capitalization is reduced by the cash paid. Market capitalization then becomes $50,000 - $1,500 = $48,500. Per share market price is then $48,500 / 1,030 = $47.09.
- Stock dividend. If the company paid out cash dividends it would have paid $3,000. However, with a stock dividend they give shares instead of cash. They would then give the shareholders $3,000 / $50 = 60 additional shares. The total number of shares outstanding is then 1,060. Because the company pays no cash dividend, the market capitalization of $50,000 remains the same, and each share is then worth $50,000 / 1,060 = $47.17.
Which scenario would you prefer if you were a shareholder? In both cases your total return is the same! Don't believe me? Let's walk through an example. Let's assume you own 1 share. In Scenario 1, you elect to receive the dividend of $3.00/share. You receive the cash but the market price is reduced because new shares are issued. Your ending total investment balance is $3.00 + $47.09 = $50.09.
In Scenario 2, you do not receive the cash dividend but you do receive additional shares of 60/1000 = 0.06. Your total number of shares is then 1.06, and your new total investment balance is 1.06 x $47.17 = $50.00. Compare that to 50.09 above (its slightly off because of rounding). The results are the same!
Scrip dividends and stock dividends are fairly similar. They are like cousins. With a scrip dividend, the shareholder has the option of receiving the dividend in the form of cash or additional shares. With a stock dividend, there is no option. The shareholder receives additional shares instead.
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