The Hindu Business Line : Stock split vs stock dividend

COGNIZANT Technology recently announced a two-for-one stock split on its capital in the form of a stock dividend. This announcement confused many readers. The reason? Was the company announcing a stock-split or a stock dividend (also called a bonus offer)? What is the between the two?

Suppose a stock has a face value of Rs 10. A two-for-one stock-split means that the Rs 10 share will be split into two shares of Rs 5 each. So, if you hold 100 shares of Rs 10 each, you will have 200 shares of Rs 5 each after the stock split.

But what if the company decides to give its shareholders one free share for every share held? A company is then said to have made a one-for-one stock dividend. This essentially means that if you have 100 shares of Rs 10 each, you will receive another 100 shares of Rs 10 each free.

The face value of the share remains the same after the stock dividend. Companies issue stock dividend by transferring funds from reserves. There is no such transfer in a stock-split.

Suppose a company has a paid-up capital of Rs 10 crore divided into one crore shares of Rs 10 each. Assume that it has Rs 25 crore as reserves. For a one-for-one stock dividend, the company will transfer Rs 10 crore from reserves to the paid-up capital. So, the capital account will now have two crore shares of Rs 10 each, while the reserves will be only Rs 15 crore.

Research studies have concluded that the price moves up after a company announces a stock-split and/or stock dividend. Stock dividend is a stronger signal, though.

When the company issues stock dividend, it has to henceforth pay cash dividend on a higher equity base. So, it has to generate more cash in the future. The signal is, therefore, stronger.

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