Security Analysis by Benjamin Graham & David L. Dodd

Author:Benjamin Graham & David L. Dodd
Language: eng
Format: epub, mobi
Publisher: McGraw-Hill
Published: 2009-03-25T16:00:00+00:00

* Excluding about $7 per share transferred from reserves to surplus.

† Calendar year 1924 compared with year ended June 30, 1914.

It is to be noted that because Atchison failed to increase its dividend the market price of the shares failed to reflect adequately the large increase both in earning power and in book value. The more liberal dividend policy of Union Pacific produced the opposite result.

This anomaly of the stock market is explained in good part by the underlying conflict of the two prevailing ideas regarding dividends which we have discussed in this chapter. In the following brief summary of the situation we endeavor to indicate the relation between the theoretical and the practical aspects of the dividend question.

Summary

1. In some cases the stockholders derive positive benefits from an ultraconservative dividend policy, i.e., through much larger eventual earnings and dividends. In such instances the market’s judgment proves to be wrong in penalizing the shares because of their small dividend. The price of these shares should be higher rather than lower on account of the fact that profits have been added to surplus instead of having been paid out in dividends.

2. Far more frequently, however, the stockholders derive much greater benefits from dividend payments than from additions to surplus. This happens because either: (a) the reinvested profits fail to add proportionately to the earning power or (b) they are not true “profits” at all but reserves that had to be retained merely to protect the business. In this majority of cases the market’s disposition to emphasize the dividend and to ignore the additions to surplus turns out to be sound.

3. The confusion of thought arises from the fact that the stockholder votes in accordance with the first premise and invests on the basis of the second. If the stockholders asserted themselves intelligently, this paradox would tend to disappear. For in that case the withholding of a large percentage of the earnings would become an exceptional practice, subject to close scrutiny by the stockholders and presumably approved by them from a considered conviction that such retention would be beneficial to the owners of the shares. Such a ceremonious endorsement of a low dividend rate would probably and properly dispel the stock market’s scepticism on this point and permit the price to reflect the earnings that are accumulating as well as those which were paid out.

The foregoing discussion may appear to conflict with the suggestion, advanced in the previous chapter, that long-term increases in common-stock values are often due to the reinvestment of undistributed profits. We must distinguish here between the two lines of argument. Taking our standard case of a company earning $10 per share and paying dividends of $7, we have pointed out that the repeated annual additions of $3 per share to surplus should serve to increase the value of the stock over a period of years. This may very well be true, and at the same time the rate of increase in value may be substantially less than $3 per annum compounded.

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