Common Stocks and Common Stockholders

This department is designed to help readers to a better understanding of the general business conditions which affect their investments. It is obviously impossible to give advice as to specific investments.

by HOW ARD DOZIER DOZIER

COMMON stockholders are residual claimants on corporate assets and corporate revenues. They are, too, the primary risk bearers, absorbing capital losses to the full extent of their original contributions to an enterprise, and in some cases double this amount, before others are called upon to suffer any loss at all. Their claim against revenues runs only to what is left after all bills, interest, and taxes have been paid, and all ordinary reserves provided for. Stockholders are equity owners, and common stock certificates are the instruments which have come to be used as evidence of this ownership. The extent of the ownership inherent in a share of common stock is a fraction whose numerator is one and whose denominator is the total number of shares outstanding. This fact is important, as we shall see, and holds good whether the price of the stock is the 1929 high or the 1932 low.

Common stocks generally are of two classes; those which have a par value and those which have no par value. Par-value stock is given a per-share monetary worth by charter, as for example $100, and the total value of all shares outstanding as shown by the books of the company is the product of this per-share par value and the total number of shares. This stated total amount may or may not be significant, but it purports to represent the original contribution of original shareholders to the enterprise either in money or in its equivalent. But if this were literally the case the total value set up on the books in most cases would have ceased long since to represent a current situation.

A corporation may have succeeded, paid dividends continuously, and built up a handsome surplus, in which each share of stock has a stake. Or it may have been unsuccessful, passed most of its dividends, and accumulated a deficit, on account of which each share has suffered an equal shrinkage. In any case it seldom happens that the market value of a stock conforms to the value calculated from the information set up on the For this reason, among others, par-value stock is coming to be supplanted by stock of no par value. Most of the issues now listed on the principal exchanges are of no par value, a change which has occurred largely within the past ten years. In the case of stock of no par value the number of shares outstanding is shown on the balance sheet and an amount of value is set opposite. This amount, however, is optional with management and is not in response to legal requirements. It is the custom of some corporations to set opposite the number of shares of no par stock the entire obligation of the company to its stockholders — that is, the sum of the capital and the surplus. This total divided by the number of shares represents the so-called book value per share. This is a convenient figure with which to compare the price at which a stock sells in the market.

Turning now from the relationship which exists between assets and common stocks, let us look at the claim which the latter have upon gross revenues. Accountants call net profits that which is left out of revenues after all operating expenses have been paid and provision made for meeting interest, taxes, and the various customary reserves. These net profits inure to the benefit of the common stockholders if there are no preferred shares outstanding — and for our purposes here we shall assume that there are none.

Generally speaking, common stockholders receive their reward in one of four ways. The board of directors may retain it for them in their property, using it to enlarge plant and equipment, or to improve and modernize it, thus increasing its value. Under such a policy, the number of shares remaining the same, each share comes to be more valuable to its owner. Second, stockholders may receive their profits in whole or in part, preferably in part only, in the form of cash dividends. Or in the third place they may receive them in the form of stock dividends. Finally they may be rewarded through what is known as the privileged subscription to stock, or the issuing of rights.

The custom of retaining earnings in a business or paying them out in the form of cash dividends needs little explanation. The more money a corporation makes, of course, and retains in the business, and converts into usable and income-producing assets, the wealthier it becomes and the richer it makes its stockholders as stockholders. In such case owners merely carry their money in their property rather than in their pockets. Such a procedure, however, is not likely to prove popular with the majority of stockholders. They will generally have made their investments in the enterprise looking to a more immediate cash income. A corporation which pursues a more niggardly dividend policy than its financial condition warrants is likely to find its stock discriminated against in the market. Hence cash dividends. The power to declare dividends or to withhold them is by law wholly within the control of the board of directors. The recourse of the stockholders is the power to elect another board which may prove more amenable.

Obviously every dollar in dividends taken out of what a corporation has depletes its assets or its potential assets by that much. But as the owners in their capacity as stockholders become poorer, they become richer as individuals. What they lose in property they gain in pulse, and thus hold their own.

A third method of distribution is the stock dividend. Profits may accumulate in the treasury of a corporation to the point which justifies a board of directors, with the consent of the stockholders, in converting the surplus, or at least a part of it, into capital stock. This the board accomplishes by giving new shares pro rata to the holders of stock already outstanding. A simple illustration will clarify the process. Let us assume that a corporation had outstanding originally 100,000 shares of common stock upon which it placed a value of $10,000,000, and that it has been able to accumulate a surplus of $5,000,000. Under these circumstances its board may decide to draw a pencil line through the $5,000,000 surplus, increase the number of shares to 150,000 and their value to $15,000,000. The company accomplishes this accounting feat by giving each shareholder one share of stock for each two formerly owned, or, as it is said, declares a 50 per cent stock dividend. The financial condition of the corporation is not changed; it makes no change in what it owns or in what it owes. Neither is the position of the stockholders changed; they owned all the equity before the dividend and they still own it all and in exactly the same amount. Only the record or the evidence of their ownership has been changed. To be sure, they each own more shares than they did, but each share is worth less in the market than when the number outstanding was less. They have not got something for nothing, as is sometimes supposed.

The fourth method of distribution is the privileged subscription. This consists in the issuing of rights to subscribe to an offering of new stock to old stockholders at a price below that prevailing in the market; as, for example, one new share at $60 for each four old shares ow ned, selling at the time. let us say, at $75. Unlike the stock dividend, this process increases both the equity and the number of shares outstanding, but the number of shares by the greater percentage. The shareequity relationship before the transaction was 4 shares ($75 each) to $300; that after it, 5 shares to $360, or $72 to the share, the new market price. The sale of the new stock increased the number of shares by 25 per cent and the equity by 20 per cent. A dilution of assets per share took place. According to the terms of the offer, 4 rights and $60 paid for one share now salable at $72. The 4 rights obviously paid $12 $.3.00 each.

Three dollars represents the theoretical value of the rights whether held and exercised or sold to another to be exercised. In either case the ownership of a right by virtue of the ownership of a share of old stock is the equivalent of a cash dividend of $3.00.

In order to realize on rights the owners of stock must take the initiative. This they do not always do. In two instances of the issue of rights which I have recently examined nearly a million dollars was forfeited because stockholders failed either to exercise their privilege or to sell the rights arising under it. In all three other modes of distribution stockholders may remain passive with impunity, but not so in the ease of the issue of rights.

One aspect of common-stock ownership already touched upon deserves especial emphasis. The owner of one share out of a million outstanding owns one one-millionth of whatever the corporation owns. And this is true regardless of the value attributed to the stock in the financial statement. The value of money may fall to the point of worthlessness without disturbing in the least this fractional ownership. Inflation may cheapen money, or raise prices, which is the same thing,to the point where a one-thousand-dollar bond of the company will not pay for a pound of butter, but still one share of the stock will command one one-millionth of the corporation’s assets in whatever form they may have survived the holocaust.

It is for this reason that ownership of common stock has come to be looked upon as an antidote, a hedge against inflation, and it is for this reason that common stocks go up in the market when inflation is in the air — or, perhaps better, when the air is in inflation.