Question

Distinguish the differences between stock splits and stock dividends in paragraph with examples.

Answer 1

stock split is when a company divides the existing shares of its stock into multiple new shares to boost the stock's liquidity. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because the split does not add any real value. The most common split ratios are 2-for-1 or 3-for-1 (which means that the stockholder will have two or three shares, respectively, for every share held prior to the split).

A stock dividend, a method used by companies to distribute wealth to shareholders, is a dividend payment made in the form of shares rather than cash. Stock dividends are primarily issued in lieu of cash dividends when the company is low on liquid cash on hand. The board of directors decides on when to declare a (stock) dividend and in what form the dividend will be paid.

Stock dividends are similar to cash dividends; however, instead of cash, a company pays out stock. As a result, a company's shares outstanding will increase, and the company's stock price will decrease. For example, XYZ Ltd. issues stock dividend or more commonly referred to as stock bonus of 1:10. This implies that each shareholder will receive one share for each 10 shares held by him/her.

Stock Splits occur when a company perceives that its stock price may be too high. Stock splits are usually done to increase the liquidity of the stock (more shares outstanding) and to make it more affordable for investors to buy. For example, ABC Ltd.’s each share has a face value of Rs.10/- and market value is Rs.1000/-. So, if the company wants to split the shares, it can split each share into two with each having face value of Rs.5/- each. Consequently the market price will also come down to Rs.500/- per share and now each shareholder will have double the quantity of shares than previously held with market capitalisation remaining intact.