A stock dividend is an issuance by a corporation of its common stock to its common shareholders without any consideration. For example, when a company declares a 15% stock dividend, this means that every shareholder receives an additional 15 shares for every 100 shares he already owns. A company usually issues a stock dividend when it does not have the cash available to issue a normal cash dividend, but still wants to give the appearance of having issued a payment to investors.
In reality, the total market value of a company does not change, just because a company has issued more shares, so the same market value is simply spread over more shares, which likely reduces the value of the shares to compensate for the increased number of shares. For example, if a company has a total market value of $10 million and it has 1 million shares outstanding, then each share should sell on the open market for $10. If the company then issues a 15% stock dividend, there are now 1,150,000 shares outstanding, but the market value of the entire firm has not changed. Thus, the market value per share after the stock dividend is now $10,000,000 / 1,150,000, or $8.70.
If a company’s shares are selling for such a large amount on a per-share basis that it appears to be keeping investors from buying the stock, a large stock dividend might sufficiently dilute the market value per share that more investors would be interested in buying the stock. This might result in a small net increase in the market value per share, and so would be useful for investors. However, a high stock price is rarely an impediment to an investor who wants to buy stock.
A problem with a stock dividend is that it may use up the remaining amount of authorized shares. For example, the board of directors may have initially authorized 15 million shares, and 10 million shares are outstanding. If the company issues a 50% stock dividend, this increases the number of shares outstanding to 15 million shares. The board will now have to authorize more shares before the company can issue any additional stock.
For example, Microsoft pays an annual dividend of $1.44, and the stock trades for $53.00 as of this writing. Therefore, Microsoft’s dividend yield is:
It’s important to realize that a stock’s dividend yield can change over time, either in response to market fluctuations or as a result of dividend increases or decreases by the issuing company.
Calculating dividend yield from quarterly or monthly dividends
Most stocks pay quarterly dividends, and some even pay on a monthly basis. In this case, in order to determine a stock’s dividend yield, you need to annualize the dividend by multiplying the amount of a single payment by the number of payments per year — four for stocks that pay out quarterly and 12 for monthly dividends.
Dividends are one component of a stock’s total rate of return, the other being changes in the share price. For example, if a stock’s price goes up by 5% this year and it pays a 3% dividend yield, then your total return is 8%. If you’re investing for the long term, be sure to consider a stock’s total return potential in addition to the yield.
It’s not all about yield
When shopping for dividend stocks, it’s important to keep in mind that a high dividend yield alone doesn’t make a stock a great investment. There are several things you should consider before investing, including (but not limited to):
- Does the company have a strong history of profit growth and dividend increases? There is a long list of companies, known as the Dividend Aristocrats, that have all increased their dividends for at least 25 consecutive years – this may be a good place to start.
- Is the company’s financial position strong? Namely, does the company have a reasonably low debt load and an investment-grade credit rating?
- Is the dividend sustainable, or is the company paying out too much of its profits as dividends? This Be sure to consider the “payout ratio,” which is the percentage of profits that a company spends on dividends. As a rule of thumb, I like my dividend stocks to pay out no more than 50% of their earnings as dividends. Real estate investment trusts (REITs) are an exception, as they are required to pay out at least 90% of their net income to shareholders.
- Does this company have the potential to grow over time? Utilities and telecom stocks tend to pay out high dividends, but they have limited growth opportunities. It’s important to create an income stream that will grow.