Excerpt from Security Analysis, a book by Benjamin Graham and David Dodd re: stock dividends and the important advantages of periodic stock dividends:
1. The stockholder can sell the stock-dividend certificate, so that at his option he can have either cash or more stock to represent the reinvested earnings. Without a stock dividend he might in theory accomplish the same end by selling a small part of the shares represented by his old certificate, but in practise this is difficult to calculate and inconvenient in execution.
2. He is likely to receive larger cash dividends as a result of such a policy, because the established cash rate will usually be continued on the increase number of shares. For example, if a company earning $12 pays out $5 in cash and 5% in stock, in the next year it will most probably pay $5 in cash on the new capitalization, equivalent to $5.25 on the previous holdings. Without the stock dividend, it would probably continue the $5 rate unchanged.
3. By adding the reinvested profits to the stated capital the management is placed under a direct obligation to earn money and pay dividends on these added resources. No such accountability exists with respect to the profit and loss surplus. The stock-dividend procedure will serve not only as a challenge to the efficiency of the management but also as a proper test of the wisdom of reinvesting the sums involved.
4. Issues paying periodic stock dividends enjoy a higher market value than similar common stock not paying such dividends.
What are you reading?
This is an excerpt from the book, “Security Analysis” by Benjamin Graham and David Dodd. Here they discuss dividend policy.
If it should become the standard policy to disburse the major portion of each year’s earnings, then the rate of dividend will vary with business conditions. This would apparently introduce an added factor of instability into stock values. But the objection to the present practise is that it fails to produce the stable dividend rate which is its avowed purpose and the justification for the sacrifice it imposes. Hence instead of a dependable dividend which mitigates the uncertainty of earnings we have a frequently arbitrary and unaccountable dividend policy which aggravates the earnings hazard. The sensible remedy would be to transfer to the stockholder the task of averaging out his own annual income return. Since the common-stock investor must form some fairly satisfactory opinion of average earning power, which transcends the annual fluctuations, he may as readily accustom himself to forming a similar idea of average income. As in fact the two ideas are substantially identical, dividend fluctuation of this kind would not make matters more difficult for the common-stock investor. In the end such fluctuations will work out more to his advantage than the present method of attempting, usually unsuccessfully, to stabilize the dividend by large additions to the surplus account.
I think they have done a wonderful job in blasting the current dividend policy which is prevalent in the markets and university finance courses. Remember that the same practise has been ongoing since 1930, and it seems to be inherently unfavourable for the stock holders as they rarely see any of their investment back in their hands.
Something to think about.