I read the following on Investopedia:
When a company wants to issue dividends to its shareholders but doesn’t have excess cash on hand, it may choose to issue a stock dividend. Companies may also choose this option as a means of decreasing the value of existing shares, driving down the price to earnings (P/E) ratio and other important financial metrics.
Isn’t this incorrect? Issuing a stock dividend decreases the price of the shares but doesn’t the EPS decrease as well?
Your earnings are $110, and you have 100 shares outstanding. Your EPS is $1.10 per share.
If you issue a 10% stock dividend you will have 110 shares outstanding, and your EPS will be $1.00 per share.
I understand the EPS will decrease, and that’s the point of the question. The article claims that a stock dividend drives down the P/E ratio.
But doesn’t the stock dividend decrease both the a) price of the share b) EPS so the P/E ratio should not change because of a stock dividend issue?
My mistake.
You’re correct: the P/E ratio should be unchanged.
Note: there are many articles on Investopedia that have errors in them.
Ok thanks! I was pulling my hair out trying to figure out how I was wrong.