Consider Dividends Paid in Stock
by R. C. BARNETT
CAN you eat your cake and have it too? That depends upon the kind of cake.
Can a farmer sow a bushel of seed wheat to an acre and get back fifteen bushels of wheat? It has been done countless times by many people.
Can a manufacturer invest a million dollars in a plant, raw material, labor, and executive skill and get one hundred thousand dollars net earnings a year? It has been done many a time.
One of the fundamental properties of wealth is that of reproduction. A small portion of wealth can be utilized so as to produce a much larger portion. This accounts for the gradual accumulation of wealth all over the world.
An investor buys stock in a manufacturing company because he wants returns upon his investment. Dividends are a necessary part of his programme. It is not sufficient to have his capital remain intact or appreciate in value unless he can at some time utilize that increased value.
THESE observations are provoked by an article in the January Atlantic entitled ‘Cash Dividends versus Stock Dividends.’ by Arthur W. Joyce. The article is far from convincing. Mr. Joyce holds that it is impossible for any corporation actually to give its stockholders anything in the nature of dividends which they did not already possess. He seems to ignore the fundamental principle of economics that wealth may beget more wealth.
Stock dividends represent equity, or ownership, in a group of assets just as much as any other form of stock. When stock dividends are declared, such stock is of course prorated among the stockholders according to their holdings. Hence there is no increase in the equity held by any of the stockholders.
When the stockholder sells his stock dividends he is selling a part of his equity and hence is getting back a part of his principal. This is not a return on his investment and is not the object sought by the investor.
THE following numerical example will help to explain my contention.
Let us assume that, at the beginning of the year, a company has assets amounting to $1,000,000 and has 10,000 shares of stock outstanding. The asset value of each share is $100. The shareholder pays this amount for it.
Let us assume that, at the end of the year, the company has not earnings (after paying all expenses of operation, overhead, fixed charges, depreciation, and so forth) of $100,000. These net earnings are available for cash dividends or for surplus, or some combination of the two.
Now let us assume that the earnings are split so that $50,000 goes for cash dividends and $50,000 is set over into surplus, thereby increasing the assets of the company to $1,050,000. The asset value per share goes up to $105.
The shareholder now has $5.00 in cash dividends and an appreciation of $5.00 per share of stock. If he sells his stock at the asset value, he has gained altogether $10.00, which is 10 per cent on his investment.
Now let us see what stock dividends will do to this situation.
Suppose the above conditions remain as assumed and that the company issues 500 shares of additional stock. The number of shares outstanding now becomes 10,500; the original assets have been increased to $1,500,000, SO the asset value per share remains as before, $100. The 500 shares of
additional stock would have to be distributed over the 10,000 original shares, or at the rate of 0.05 per share.
The shareholder has a cash dividend, as before, of $5.00. His equity remains unchanged,— that is, he still owns a 1/10,000 part of the assets of the company, — but there has been no appreciation per share, for the asset value remains at $100. So far his stock dividend is merely an acknowledgment on the part of the company that he has a proportional interest in the surplus.
If the shareholder sells his original stock and the stock dividend at the asset value he will receive $105. It is readily seen that the stockholder has thereby gained $5.00, which, added to his cash dividend of $5.00, leaves him a total gain of $10.00, as in the first case.
If he sells his stock dividend alone, he
is selling a part of his ownership in the assets of the company as much as if he sells his original share. Instead of owning a 1/10,000 part of the assets as he first did, he now owns only 1/10,500 part. He has sacrificed a part of his principal; he has gained no appreciation in asset value, and simple has his $5.00 cash dividends for his returns on his investment.
The stock dividend has provided him a convenient means for getting a part of his investment back, which is not the same as receiving profits.
THE company has gained no additional cash assets over and above the $50,000 surplus set over from its earnings and has lost, the prestige of stock appreciation. The issuing of stock div idends reduces to a mere gesture, and for what purpose? Does the company want to gain the reputation of trying to flimflam the investor into believing that stock dividends represent profits to the investor?