As a company issues shares instead of dishing out cash as dividend, its paid-up capital gets bigger
As debates rage over the proposed 15 percent tax on bonus shares issued by listed companies, it is worth taking a look at the good and bad sides of companies issuing stocks instead of giving cash as dividends.
As a company issues shares instead of dishing out cash as dividend, its paid-up capital, which is the shareholders’ contribution to the company, gets bigger.
This means the next year the company will have to make more profit if it has to pay dividends on a larger number of shares. Otherwise, its dividend will be poorer and the company’s share price will fall as the market will view the company as no longer a lucrative one to invest in.
So unless the company knows its future is great, unless it knows enlarging its share base is sustainable, and unless it has a long-term vision for its business, a company does not opt for stock dividends.
However, such a practice may be a ticking time bomb for a company - if its business does not grow proportionate to the growth of shares it falls into deep crisis. Its share prices erode in the market as the company’s earnings per share and net asset value, measured by adjusting a company’s total assets with its liability, fall for each share.
On the flipside, when the company gives stock dividends, it can retain its reserve or the money it has accumulated in its accounts. This gives the company greater leeway in investing in various profitable ventures, or easily expand its existing business without getting stretched on funds.
Many companies find it comfortable to simply give cash dividends. This keeps the company slim and relieves it from the burden of future dividend liability. As its number of shares stays within limits, it does not have to worry much about more profitability or liability to shareholders.
So both the practices of giving cash dividend or issuing stock dividend have inherent positive and negative attributes.
In Bangladesh, however, the practice of stock dividend is often abused.
Certain quarters closely connected to companies have prior knowledge that these companies are going to offer stock dividend and accumulate shares from the market, later also often spreading rumours about rosy future prospects of the company.
Then as the companies declare stock dividends, it sends the share prices on an upward spiral. When the price picks, these company insiders or manipulators dump their accumulated shares and make hay.
It is however a mystery why prices shoot up when stock dividend is declared. Logic dictates it should have worked the other way round, as stock dividend broadens the share base of a company and dilutes its assets and earnings. And so the company’s future dividend liabilities increase.
Such upward spiral of price, following declaration of stock dividend, is rife.
For example, Stylecraft Limited shares traded between Taka 1200 to 1400 in the first half of 2017. Then as it declared 80 percent stock dividend, along with a 10 percent of cash in October that year, its prices shot up to as high as Taka 2,890 per share. After record date – when the company formalises its dividend recipients - the stock price dropped to pre-declaration level of Taka 1,300 and remained there.
The very next year the company issued a 410 percent stock dividend and before the record date, its share price shot up to Taka 4900 for each share. After record date in 2018, the stock the price dropped back to Taka1400 per share.
By holding on to Stylecraft shares for a year and a half, manipulators earned 10 times return on their money invested. Such incidents create false expectations among naive investors, who believe in the strength of stock dividend.
Another example of unbelievable bonus share return may be Monno Jute Stafflers Limited. The company issued a 350 percent of stock dividend and its stock price skyrocketed to 5500 Taka each share from 800 Taka earlier that year. The company showed a good growth in profit per share too.
But as shareholders start offloading their holdings for profit-taking, prices fell sharply and panic spread across the market.
There are companies whose ‘growth stories’ dissipated with the market bull disappearing. Keya is one such company whose share price rose to Tk 160 a share with the successive declarations of stock dividend and then bottomed to Tk 4.5 only, leaving investors high and dry.
To rein in such malpractice, the Bangladesh Securities and Exchange Commission has made it mandatory for companies to justify their decision for stock dividend instead of cash handout.
Square Pharmaceuticals is however a different story.
It is a well managed company that declares bonus shares each year and yet keeps up steam. The company is growing and it meets its investment requirement from the reserve it retains, and holding out on cash dividend. It has a stable share price in the market.