Scrip Dividends: How Companies Reward Shareholders

Companies frequently distribute a portion of their profits to shareholders as dividends. While cash dividends are prevalent, some companies opt for scrip dividends, eliminating the need for immediate cash payments. Let’s delve into how this type of dividend functions and explore its intricacies further.

What is Scrip Dividend?

Heard about cash dividends but wondering what is scrip dividend. Public and private companies distribute profits to shareholders based on shareholders’ holdings. However, in cases of financial constraints or strategic reasons, companies may opt for scrip dividends, offering shareholders additional shares instead of cash. This allows companies to preserve cash for various purposes while still rewarding shareholders.

In this type of dividend, instead of paying cash, the company provides additional shares to investors. Also, shares offered through this type of dividends come at a discounted rate. It eventually helps shareholders to increase their stake in the company.

How Does a Scrip Dividend Work?

While there’s technically just one Interest Coverage Ratio (ICR), its calculation can vary slightly depending on the context and financial statement used. Here are the main variations:

As discussed above, a company might decide to issue scrip dividends due to several reasons. Companies might issue them when they don’t have cash. On the other hand, some companies want to save cash for other purposes. Once companies decide to distribute these dividends, they inform shareholders beforehand.

Companies often entice shareholders to opt for these dividends by offering shares at a discounted rate. One can get dividend stocks at a lower than the market price. An existing investor will get dividend stocks based on their current holdings.

Most companies give investors the choice between both types of dividends. However, there might be cases where companies strictly offer cash dividends to existing shareholders.

Scrip Dividend Formula

Now that you understand what the scrip dividend is, let us discuss the calculation formula. One can calculate the number of additional shares through this dividend with this formula:

Number of Additional Shares = (Dividend Amount for Each Share/Market Price for Each Share) * (1-Discount Rate)

In the above formula, the discount rate is the reduction in price (by percentage) for additional shares. Existing shareholders are offered new shares at a discount rate. Also, you don’t have to worry about calculating the number of additional shares. The issuer will calculate and issue new shares accordingly to investors.

Example

Now that you understand the scrip dividend meaning, let us discuss an example. Let us say a company decides to issue such a dividend at a 10% discount rate. The dividend amount per share is Rs 3, while the current market price of a share is Rs 100. In such a case, the number of additional shares per existing stake would be –

Number of Additional Shares = (3/100) * (1-0.10) = 0.027

It means that an investor will receive 0.027 shares for each existing share in the company.

How Do Companies Issue Scrip Dividends?

Now that you have understood the scrip dividend example, let us delve deeper. Companies notify the investors beforehand about these dividends. They let shareholders know about it during regular dividend declarations. Shareholders are provided with ample time to choose between both types of dividends.

Shareholders usually submit a form online to make their choice. The company calculates the number of additional shares. Investors will be notified of the discount rate to get additional shares at a lower price.

Additional shares are added to the existing holdings of shareholders. The company updates its ownership records after issuing additional shares to some investors. The ownership percentage for each investor will change due to the launch of new shares. These new shares can entitle the investor to receive additional cash dividends in the future.

Importance of Scrip Dividend

Scrip dividends are essential, as they provide a new way of paying shareholders. Without it, companies would have to pay cash dividends to shareholders at all times. It allows companies to preserve cash for future activities while paying shareholders at present. Also, some companies might face a shortage of cash due to plummeting financial performance. Such companies can take a breather by announcing other types of dividends.

It provides a new way to reward existing shareholders. Adding new shares to the portfolio of shareholders can change their ownership stake in the company. It’s like shareholders are re-investing their gains in the company. Some also provide more cash dividends or payouts in the future, thus increasing the profit in the long run.

Benefits of Scrip Dividend

Are you wondering whether to choose cash or scrip dividends? Know about these benefits before you make the decision:

• Dividends allow investors to re-invest their earnings in the same company. When you get additional shares, you are reinvesting your dividends in the company. Not to forget, you will be buying additional shares at a discounted rate.
• You might remember how returns are reinvested in a mutual fund scheme to benefit from compounding. Similarly, it allows investors to benefit from compounding by re-investing returns.
• Most companies offer investors the flexibility to choose between cash or scrip dividends. You can choose to stick to traditional cash dividends.
• Companies might start paying cash dividends in the future. Thus, your total dividend yield will increase. Your ownership stake in the company will change by accepting additional shares.

Limitations of Scrip Dividend

Scrip dividends have certain limitations, such as:

• It will not provide you with cash. However, they might increase your tax burden in some jurisdictions. It is essential to research tax implications before accepting this type.
• Investors might prefer cash in hand at times. However, the other type of dividends will not provide you with additional cash. You can only get additional shares.
• Ownership stakes are sliced when a company issues new shares. Ownership stakes might be diluted due to such dividends.
• You already know that it offers additional shares at a discounted rate. Now, the returns on these shares might be lower than those brought at market price.
• These dividends can be complex for some investors. Also, they might give out a signal that the company does not have ample cash to distribute traditional dividends.

Difference Between Scrip Dividend and Stock Dividend

Investors might confuse scrip dividends with stock dividends. Here are the differences between the two:

Conclusion

Investors must be familiar with the concept of scrip dividends. They allow a shareholder to get additional shares at a discounted rate. These shares will increase the dividend yield in the future. Usually, companies provide investors with the option of cash dividends along with additional shares. However, some companies might directly issue stock dividends, which do not come with a choice.