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Stock splits, dividends and reverse splits
Technically, stock splits, stock dividends, and
reverse stock splits have no monetary effect on one’s investment. They just
change the number of shares owned, resulting in a proportionate change in
the share price, with no overall change in the total value of the
investment. There are no tax consequences for non-cash stock reallocations.
The nuances of each are discussed below:
Stock splits
Stock splits are an increase in the number of total
shares outstanding of a company, with a proportional decrease in the share
price and dividend of the company. Stock splits have no effect on the
overall market capitalization of the company. The individual shareholders
receive more shares, but their percentage ownership is the same, as is their
overall cost basis, dividend, and original purchase dates. Usually,
companies have 2 for 1, or 3 for 2 splits, but other combinations can also
be used.
The investment strategy of buying a stock when a
split has been announced and selling when the split occurs is no longer in
favor. Companies split their stock for various reasons, such as:
·
Maintaining a price that is attractive to the average investor
·
Increasing the company’s outstanding floating shares
·
Broadening the company’s investor base
Stock splits are usually indicative of a forward
moving company that is growing and improving shareholder value.
Accounting treatment: “Memo” accounting entries are
made with stock splits that increase the authorized and outstanding shares
of the organization. Also, the company’s par value per share is
proportionately adjusted, as well as all the historical stock charts.
Newspaper treatment: Some newspapers identify those
stocks that had a split during the prior 52 weeks by having an “S” next to
the company’s name. They also restate all prior share price statistics to
reflect the stock split.
Stock dividends
Stock dividends are theoretically similar to a stock
split, in that the number of shares outstanding increase, with a
proportional decrease in the share price. The scale of a stock dividend is
much smaller, usually between 1% and 25% of the outstanding shares; above
that is considered a stock split. As with a stock split, the shareholders
receive more shares, but their percentage ownership is the same, as is their
total cost basis and original purchase dates. The original dividend rate may
or may not be reduced; every transaction is different.
While most of the stock charts and newspapers
automatically make the proportionate changes for small stock dividends, some
may not note it on the charts, because of spacing issues. In effect, one
often receives more shares, with the same dividend rate. Additionally,
management’s intent in paying a non-cash dividend is to show shareholders
and the investing community, that the organization is growing in value, and
is rewarding its shareholders. A cash dividend may not be available to the
shareholders, but remuneration is still intended.
Accounting treatment: Stock dividends are accounted
for as a non-cash dividend. As such, the accounting records are adjusted by
debiting retained earnings for the fair market value of the dividend and
crediting common stock at par value, with the difference being credited to
additional paid in capital. This has zero impact on shareholders’ equity,
but reduces the retained earnings of the company, for the value of the
dividend.
Tax treatment: Generally, stock dividends, as well as
stock splits, are non-taxable. There are a few exceptions, such as: if the
company gives one an option for cash or stock, that option may make the
transaction taxable, irrespective of the owner’s choice. Additionally, if
the shareholders are not treated the same, and receive disproportionate
distributions or different amounts, types, classes or terms, the
distribution may be taxable. If shareholders receive any inequitable
treatment, the transaction may be taxable. If common shareholders receive
certain preferred stock, the transaction may be taxable. With unusual
distributions, always consult with the company or the IRS, as to the tax
consequences, before filing the annual 1040 tax return.
Stock dividends are a good way for management to show
investors that the company recognizes their ownership position, and is
working at increasing the value of their investment.
Reverse stock splits
A reverse stock split is the opposite of a regular
stock split.
Usually the company has had a “series of eroding
fundamentals; it is a last ditch effort to keep the stock listed on
exchanges as a marginable security.” It’s a natural process in reflecting
the declining value of an enterprise. Usually, dividends have already been
discontinued. Most stocks need to trade above $1 per share to maintain their
listing on the stock exchanges and trade at or above $5 per share to be
marginable. Shareholder approval is not needed for reverse stock splits. I
believe, in most cases, these stocks continue to decline until they
ultimately go out of business.
There are, however, cases where a stock previously
bottomed-out, and now fundamentals are improving, and the institutional
investors and analysts are recommending that the company reverse split their
shares, to increase its stock price, thus making it eligible for
institutional purchase. Reverse splits also reduces trading costs. These are
the types of turnaround companies that speculative investors should look
for.
Lab Corp of America is a good example. Their product
is a healthcare necessity in today’s world. Emergency room doctors cannot be
certain that a critically ill patient is having a heart attack until a
series of blood work is done over a prolonged period of time. Blood testing
is essential in the healthcare industry.
Back in the mid-to-late 1990’s Lab Corp had a series
of mishaps, combined with changing governmental billing procedures at the
doctor level, which took time to implement. This resulted in a company that
was obviously improving, but was not yet recognized by Wall Street. They
first had a 10 for 1 reverse split in 2000, followed by two 2 for 1 splits
in 2001 and 2002. This was obviously a success story.
Lab Corp’s
example may also be the footprint that some of the post-bubble technology
companies can use, to correct the distortion between their stock price and
their fundamentals. This can be a valuable and potentially profitable case
study for investors.
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