In finance and investment, dividends are significant as they signify a company's triumph and its intent to distribute profits among its shareholders. While conventional cash dividends enjoy wide recognition, a captivating alternative often goes unnoticed – the Scrip Dividend.

Investors invest in the stock market to ensure that the amount they have saved multiplies at a higher rate than their savings account. However, when it comes to the stock market, there is always a possibility that the stock may fall in price if it sees higher volatility for the sake of providing higher returns through capital appreciation. Hence, risk-averse investors with a lower risk tolerance look towards dividend-paying stocks that are lower in risk as they do not experience much volatility. Dividends are the amount paid by companies to their shareholders by distributing a portion of the earned profits. However, dividend-paying companies may opt for a different method of paying dividends called a scrip dividend.

If you are a shareholder of a company that has announced dividends, it is important to know the scrip dividend’s meaning. This blog will help you understand scrip dividends and help you decide if you should choose such a dividend if offered by a company.

Scrip dividend’s meaning refers to a type of dividend in which the company offers additional shares of the company to the shareholders rather than cash. Scrip dividend is also known as dividend reinvestment plan (DRIP) as the dividend offered as additional shares results in company shares being purchased by the shareholder, reinvesting the amount.

The companies calculate the amount announced as dividends per share and offer additional company shares, equalling the dividend amount. Scrip dividends increase the ownership of the shareholders in the company, which may offer better returns through future cash dividends and capital appreciation.

A scrip dividend allows current shareholders to receive dividends in the form of additional shares instead of cash. When a company declares a scrip dividend, shareholders are notified and given the choice to opt for cash or shares. If they choose additional shares, the new shares are calculated based on the dividend amount and current share price. The company then issues the new additional shares of the company to the shareholders who opted for the scrip dividend. This also increases the company's total outstanding shares and helps save cash within the company as dividends are not paid using company profits.

Most companies offer the new additional shares to shareholders under the scrip dividend option at a discounted price. Hence, they receive more shares than they would have in reality at the current trading stock price. The discounted price is offered to attract shareholders who choose the scrip dividend option over cash dividends.

Read more: What is SEBI

Companies calculate scrip dividends using the following formula:

Number of additional shares offered through scrip dividend = (Dividend amount / Market price per share) x (1 - Discount rate)

Here, the discounted rate is the reduction in stock price per share at which the company is offered the scrip dividend.

Here is a scrip dividend example:

Let’s assume that a company XYZ declares a dividend of Rs. 2 per share, and shareholders are given the option to receive this dividend in the form of additional shares. The current market price of the company's shares is Rs. 20. To make the scrip dividend more attractive, the company offers a 10% discount on the market price of the new shares.

Here is how the calculation works:

Number of additional shares offered through scrip dividend: (Dividend amount / Market price per share) x (1 - Discount rate)

Number of additional shares offered through scrip dividend: 2/20 x (1-0.10) = Rs. 0.09

So, for each existing share, a shareholder would receive 0.09 additional shares.

Here are the steps included in the issuance of scrip dividends:

• Declaration: The company announces per share dividend and offers the option to choose scrip dividends.

• Notification: The notification about the option includes the details of the scrip dividend, such as the issue price of the new shares and the timeline for making a decision.

• Selection: The shareholders must choose or reject the scrip dividend option within the given timeframe.

• Calculation: The scrip dividend is calculated based on the dividend amount and the issue price of the new shares.

• Issuance: The company issues the new shares to the shareholders who opted for the scrip dividend.

A scrip dividend and a stock dividend both issue additional shares to shareholders instead of paying cash dividends, but they differ in their execution. A scrip dividend offers shareholders a choice between receiving cash or additional shares as dividends. In scrip dividends, the additional shares are offered at a discount. In contrast, a stock dividend automatically issues additional shares to all shareholders based on their existing holdings, generally without a discount.

Read more: Covered call

A scrip dividend offers shareholders the choice between receiving a cash dividend or additional shares, often at a discount to the market price. On the other hand, bonus dividends provide extra company shares without any dilution of ownership or associated payment.

Scrip dividends are important for companies as they allow them to preserve cash while still rewarding shareholders with additional company shares and offering them flexibility. They also allow them to strengthen their balance sheet and increase their outstanding shares. Although scrip dividends might signal potential cash flow problems, they indicate that the company remains committed to rewarding its investors despite cash flow challenges.

Read more: Strike price

Here are the benefits of scrip dividends:

• Reinvestment: Investors can easily reinvest their dividends in company shares, increasing ownership.

• Compounding: With extra shares, investors can earn more dividends when the company announces cash dividends.

• Flexibility: Investors are given the option to choose between cash or scrip dividends, offering flexibility.

• Long-term growth: With more shares, investors can earn better in the long term due to capital appreciation.

Here are the limitations of scrip dividends:

• Tax implications: Scrip dividends can make investors liable for taxes in some cases.

• Liquidity: Scrip dividends may result in tying up investor funds in additional shares rather than providing upfront cash.

• Ownership: Scrip dividends may dilute investor ownership due to an increase in outstanding shares.

• Low returns: The additional and existing shares may fall in price after dividend distribution, resulting in lower returns.

Read more: Free cash flow

Scrip dividends are a type of dividend that allows investors to receive additional company shares rather than cash as dividends. Such dividends ensure that companies can preserve cash and reinvest in company shares, offering flexibility to the investors. Now that you know the scrip dividend’s meaning, you can better decide if you should opt for scrip dividends if announced by a company.