American Capital Agency Corp. (AGNC) does not own any controlling interest in another company’s stock. Also, it has never received any stock dividends. Therefore, no adjustments to its earnings are necessary for fictitious value placed on stock dividends received.
Read the relevant section from Securities Analysis below to see how some other companies in the past have padded their earnings with fictitious stock dividend values.
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Fictitious Value Placed on Stock Dividends Received. From 1922 on most of the United Cigar Stores common shares were held by Tobacco Products Corporation, an enterprise controlled by the same interests. This was an important company, the market value of its shares averaging more than $100,000,000 in 1926 and 1927. The accounting practice of Tobacco Products introduced still another way of padding the income account, viz., by placing a fictitious valuation upon stock dividends received.
For the year 1926 the company’s earnings statement read as follows:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,790,000Income tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000
Class A dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,136,000
Balance for common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,254,000
Earned per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Market range for common . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117–95
Detailed information regarding the company’s affairs during that period has never been published (the New York Stock Exchange having been unaccountably willing to list new shares on submission of an extremely sketchy exhibit). Sufficient information is available, however, to indicate that the net income was made up substantially as follows:
Rental received from lease of assets to American Tobacco Co. . . . . . . . . . . $ 2,500,000
Cash dividends on United Cigar Stores common (80% of total paid) . . . . . $ 2,950,000
Stock dividends on United Cigar Stores common
(par value $1,840,000), less expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 5,340,000
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,790,000
It is to be noted that Tobacco Products must have valued the stock dividends received from United Cigar Stores at about three times their face value, i.e., at three times the value at which United Cigar charged them against surplus. Presumably the basis of this valuation by Tobacco Products was the market price of United Cigar Stores shares, which price was easily manipulated due to the small amount of stock not owned by Tobacco Products.
When a holding company takes into its income account stock dividends received at a higher value than that assigned them by the subsidiary that pays them, we have a particularly dangerous form of pyramiding of earnings. The New York Stock Exchange, beginning in 1929, has made stringent regulations forbidding this practice. (The point was discussed in Chap. 30.) In the case of Tobacco Products the device was especially objectionable because the stock dividend was issued in the first instance to represent a fictitious element of earnings, i.e., the appreciation of leasehold values. By unscrupulous exploitation of the holding-company mechanism these imaginary profits were effectively multiplied by three.
On a consolidated earnings basis, the report of Tobacco Products for 1926 would read as follows:
American Tobacco Co. lease income, less income tax, etc. . . . . . . . . . . . $2,100,000
80% of earnings on United Cigar Stores common . . . . . . . . . . . . . . . . . .$ 6,828,000*
$7,928,000
Class A dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 3,136,000
Balance for common . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,792,000
Earned per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7.27
* Excluding leasehold appreciation.
The reported earnings for Tobacco Products common given as $11 per share are seen to have been overstated by about 50%.
It may be stated as a Wall-Street maxim that where manipulation of accounts is found, stock juggling will be found also in some form or other. Familiarity with the methods of questionable finance should assist the analyst and perhaps even the public, in detecting such practices when they are perpetrated.
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