Chapter 30: Stock Dividends
In theory a large
stock dividend
gives the stockholder nothing that he did not own before. His two
pieces of
paper now represent the same ownership formerly expressed by one piece
of
paper. This reasoning led the United States Supreme Court to decide
that stock
dividends are not income and consequently not subject to income tax. In
practice, however, a stock dividend may readily be given exceptional
speculative importance. For stock speculation is largely a matter of A
trying
to decide what B, C and D are likely to think—with B, C and D
trying to do the
same. Hence a stock dividend, even if it has no real significance of
any kind,
can and does serve as a stimulus to that mutual attempt at taking
advantage of
each other which often lies at the bottom of speculators’
activities.
Graham recommends the
following
as suitable dividend policies:
- Withholding and
reinvestment of a substantial part of the earnings must be clearly
justified to the stockholders on the grounds of concrete benefits
therefrom exceeding the value of the cash if paid to the stockholders.
Such withholding should be specifically approved by the stockholders.
- If retention of
profits is in any sense a matter of necessity rather than choice, the
stockholders should be advised of this fact, and the amounts involved
should be designated as “reserves” instead of as
“surplus profits.”
- Earnings
voluntarily retained in the business should be capitalized in good part
by the periodic issuance of additional stock, with current market value
not exceeding such reinvested earnings. If the additional capital is
subsequently found no longer to be needed in the business, it should be
distributed to the shareholders against the retirement of the stock
previously issued to represent it.