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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:

  1. 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.
  2. 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.”
  3. 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.

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