Talking about stocks and shares is always a complex topic to understand and discuss. This realm is still undiscovered by a large chunk of the population. When we try to go deep into this area, various new concepts come to mind, and we are not very familiar with those concepts. Stock splits and stock dividends are also two of those topics in which we are often confused.
In this article, we will try to cover all those aspects of stock splits and stock divisions that are still undisclosed and will help you learn the difference between stock splits and stock dividends clearly.
Stock split vs. Stock division
When we discuss the difference between a stock split and a stock dividend, the basic difference is that in a stock split, One share of a firm is split into a greater number of shares with a reduced face value. This division is carried out so that, following the split, the company's entire market capitalization remains unchanged. A stock's price may rise as its value increases to the point where certain investors are unable to purchase it. Through the division of stock into many shares, stock splits lower the price of a stock. But a stock dividend is a payment made to shareholders in the form of additional equity shares as opposed to cash. In this scenario, every stockholder receives additional shares from the firm's free reserves, but the total market value of the company stays the same. The company's lack of cash flow is the primary cause of the stock dividend.
Difference between a stock split and a stock dividend in tabular form
|Parameters of comparison||Stock dividend||Stock split|
|Meaning||A stock dividend is simply the distribution of the company's own stock on a pro-rata basis to the shareholders||A stock split is a process that involves the division of the existing outstanding shares into a small number of shares.|
|The number of shares||The number of shares in a stock dividend increases by the proportion of the stock dividend.||In a stock split, the number of shares increases, but by a fraction.|
|The rationale of the company||In the case of stock dividends, they are a substitute for cash dividends.||In the case of a stock split, it will increase the liquidity of shares.|
|Benefits to||In stock dividends, the benefit is to existing shareholders.||In a stock split, the benefit is to existing and potential shareholders|
|Requirement for journal entry||Stock dividends require journal entries.||Stock splits do not involve journal entries|
|Objectives||The organisation objective from stock dividends is to distribute accumulated earnings without providing dividends to raise the creditworthiness of the company||The objective of a stock split is to increase affordability for small retail investors and market liquidity; in this way, it can help attract new investors.|
|Reason||Its purpose is to reward existing shareholders for the investments they have made.||Its purpose is to increase the marketability of the shares.|
What is a stock dividend?
The payment of profits to equity shareholders is known as a dividend. Cash dividends and stock dividends are the two types of dividends. A dividend paid to investors in the form of stock as opposed to cash is known as a stock dividend. The stock dividend has the additional advantage of rewarding shareholders without depleting the company's cash reserves, despite the fact that it lowers earnings per share. Usually paid out as fractions of existing shares, these stock distributions
In addition to or instead of the cash dividend, stock dividends are paid. When a business declares and issues extra shares of its own stock to the current shareholder, that is when it happens. Just like cash dividends, stock dividends are announced by the board of directors on a certain day.
But in this case, it is important to keep in mind that a rise in the number of outstanding shares diluted earnings per share, which lowers share prices. The stock dividend could be referred to as a bonus issue in everyday speech. A bonus issue is, in essence, the issuance of additional shares by the corporation as a reward to the current owners without charging a premium. This indicates that the business provides them free of charge.
It does not require the use of cash. It is up to an organisation to decide how to distribute stock dividends when it does not have sufficient cash to declare and distribute the dividend. It decreases the market price of stock due to this increasing the stock's marketability. But it also leads to an increase in the share's market price. Therefore, it may look more attractive to a lot of investors. It does not represent the income to the recipients, which is taxable.
Additionally, it meets owners' dividend expectations without costing money.
The composition of the shareholder's equity is changed in the case of a stock dividend. It is because it leads to the transfer of a proposition of retained earnings to paid-up capital. In reality, it distributes the company’s general reserves into the share capital of the company. The company's general reserves include the share premium. This is received by the company from the shareholders. Although the entire stockholder’s equity is untouched, The par value per share has no effect. but when the additional shares are issued. The outstanding shares increased.
For example, let's say X Ltd. has 1,000 shares. The remaining profit is Rs. 50,000. The profit per share is therefore Rs. 50 per share. The management of the corporation intends to distribute a 20% equity dividend. As a result, a shareholder who has 100 shares will also receive 20 more shares.
What is a stock split?
It is a method by which a company distributes its existing shares into multiple small units. This results in an increase in the outstanding number of shares; however, there is no effect on the total value of shares. Because this split does not lead to cash consideration. A stock split is a type of process that involves the subdivision of outstanding stock units without any change in the paid-up share capital. Due to this, there is a fall in the par value. Also, the outstanding shares are multiplied automatically. It does not have any effect on the organization's equity capitalization. Hence, it does not have any effect on the net assets of the company.
A stock split is also regarded as a corporate move in more technical terms; under this, the face value of the organization's existing shares is divided into a specific ratio. By the time the stock split is done, the quantity of shares in the firm tends to rise. But there is no impact on the market capitalization.
It is a company's decision to take action when the price of a company is going up; due to this reason, all retail investors face difficulty investing in them. So, a stock split leads to a substantial decrease in the share's market price. As shares are split. This occurs as the number of shares in a company rises. By doing so, the company keeps its shares in a demanding trading range, which helps it attract more buyers.
However, market capitalization is not affected by stock splits. Also, the value of the shareholder’s investment remains unchanged. Nevertheless, the price of each share declines due to an increase in the number of shares. To make shares easy to purchase and affordable for investors. Companies prefer to go for the stock split and
Conceal the large profit distribution as with the stock split, per share earnings fall. It also benefits the upcoming sale of new shares. Also, provide a basis for an exchange in the event of a merger.
Things important to remember
- Here, it is important to notice that the shareholder's proportion is the same in both scenarios.
- Both stock dividends and stock splits, which involve the issuance of additional shares to shareholders on a pro rata basis, are significant components of dividend policy.
- The net assets, risk, earnings, and ownership proportion of the company are all the same in both scenarios.
- The final result of these two plans would be an increase in the number of outstanding shares.
How the stock splits affects
- The size of the split has an inversely proportional impact on the market value of the shares. Paid-in capital, retained earnings, and stockholders' equity won't be impacted. Additionally, it raises demand and liquidity.
So is it useful?
After the introduction to stock splits, we can now discuss if they are useful for a firm or not and why a firm should go for a stock split. A stock split typically indicates that a company is succeeding and that its stock price has increased. This is advantageous, but it also implies that stockholders now have to pay more for it. Companies may decide to divide their shares to make them more accessible and appealing to regular investors. Although stock splits can increase a stock's liquidity and accessibility to investors, not all firms do so.
Difference between stock split and stock dividend in points
- In the case of a stock dividend, the company's share capital rises,but its reserves get reduced proportionately. But in the case of a stock split, the share capital and reserves of the company remain the same.
- The future dividend per share in stock dividends remains the same because the face value remains the same. But in stock dividends, the future dividend falls with the decrease in the face value.
- The face value of the shares in a share dividend remains the same after the stock dividend, and after this, it decreases the market price of the shares. The share split reduces in proportion to the split ratio.
- A company makes public the information that it pays stock dividends when it lacks cash liquidity. But a stock split is informed when the market price of a share is overvalued and there is a desire to make it tradable.
- When a company declares stock dividends, there is no change in the share's face value. In contrast, in a stock split, there is a fall in the face value of the share.
- When there are stock dividends, additional shares are issued by the company to the shareholders in a specific proportion for free. Stock splitting is the division of the face value of a share of a company. In this, the company's shares are divided into multiple parts.
- The goal of a stock dividend is to distribute accumulated profits without paying dividends in order to increase the company's creditworthiness. The purpose of a stock split is to make stocks more accessible to small retail investors and to make the market more liquid, which may help draw in new investors.
- Only current stockholders are eligible for stock dividends. Since share prices have dropped, both current investors and prospective ones stand to gain.
- When the business is unable to pay a cash dividend, stock dividends are typically issued. Stock splits are carried out to increase share liquidity.
- Based on present share ownership, a stock dividend distributes a certain number of shares without charge. To increase the number of shares, a stock split divides the existing shares into multiple shares.
To conclude the difference between a stock split and a stock dividend, we can summarise it as the number of outstanding shares rising as a result of both stock splits and dividends. The fundamental distinction between a stock dividend and a stock split, which have similar effects, is dependent on why they are issued. Stock dividends are a viable choice for short-term cash shortages, but many investors may not like this strategy since they prefer the predictable income that only cash dividends can offer. A company may prefer a stock split or a stock dividend depending on their strategy and policies for long-term business growth. This decision is also influenced by the expectations of a company from their shareholders, and they want the investors to reach the market while making sales and purchases of the company's shares.