Monday, December 3, 2012

BBE Continues To Grow....Slowly

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

Having revisited Best Blogs Ever, Inc. (BBE) in the last few blogs, we return to the story.  The story of BBE is patterned after a narrative about a fictional business contained in How to Buy Stocks, a guide to successful investing, written by Louis Engel and first published in 1953 followed by revised editions every few years ever since.  New financial terms introduced in the story will be highlighted in bold when we meet them.  I realize that for many readers much of the information and terms may be old news, but some readers may not be familiar with many of the terms used in the financial world, so this story is for them and, hopefully, a refresher course for the more experienced of you.  We pick up the story after the investment in BBE by VFI.

The $70,000 invested in Best Blogs Ever, Inc. (BBE) by Venture Funds, Inc. (VFI) allowed BBE to set in motion its purchase of new servers, its office expansion and the hiring of additional employees.  However, all of this took time and effort to accomplish.  The delays experienced in taking delivery of the additional equipment, getting it installed in the newly built out floor of office space and training the new hires meant that the anticipated increase in revenues did not begin for many months after VFI's investment.  Despite these delays, the Board of Directors had to pay the required dividend of 2% on BBE's preferred shares, $1,200 on the first anniversary of their purchase by VFI.

The year's operations before the VFI investment had resulted in $5,000 of earnings with a distribution of $1,500 to the original shareholders.  Although BBE was able to maintain that level of earnings during the expansion, the money was needed to support the increased operational costs.  The preferred shares' dividend of $1,200 was paid as required, leaving $3,800 in earnings, which had to be plowed back into the business.  The Board of Directors felt that they could not prudently declare a cash dividend on the common shares.  In other words, the Directors would have to pass the dividend and keep the earnings in the company.  This is not the sort of news that shareholders want to receive.

After the Articles of Incorporation of BBE had been amended, the common stock split 10 for 1 and the VFI investment received, BBE had 41,000 authorized but unissued shares remaining.  After securing the consent of the shareholders, the Board declared a stock dividend on a 3 for 2 basis.  Each shareholder received 1/2 of a share of stock, at no cost, for each share he or she already owned.  It may take some time for financial benefits to be realized from a stock dividend, but if BBE continues to prosper, some benefit should be received down the road. 

In a way, a stock dividend is similar to a stock split because everyone ends up with more shares resulting in the same percentages of ownership.  However, those extra shares may result, ultimately, in extra dividends being paid to the shareholders since they now have additional shares on which additional dividends could be paid at a later date.  If prior to the stock dividend, a BBE shareholder had 1000 shares and was to receive a cash dividend of 5 cents a share, then he or she would receive $50.  After the 3 for 2 stock dividend, that same shareholder would have 1500 shares.  That same 5 cents a share dividend would net the individual $75, and the shareholder would not have spent any money for the extra shares and the larger cash dividends. In the case of a stock split, the dividend per share is reduced in inverse proportion to the stock split.  If there is a 3 for 2 stock split, the shareholder with 1,000 original shares also ends up with 1500 shares; however, the dividend per share is reduced from 5 cents per share to 3.3 cents per share, so the dividend remains $50. 

After several years, the hoped for benefits of the expansion were realized, and BBE now had annual revenues of $10,000, which allowed the Directors to pay the preferred share dividends ($1,200); provide a dividend of 50 cents a share on the common stock ($6,750), and keep the rest of the income in the company to support operations.  This was a good rate of dividend growth since the dividends paid at the time of the VFI investment had been 30 cents a share after the stock split.  Now the benefit of the stock dividend was enjoyed by the owners of the common stock.  VFI received its fixed dividend on its preferred shares, and it also participated in the benefits of BBE's increasing revenues and dividends through its common shares.

BBE now had 13,500 shares of issued common stock, i.e., the 9,000 shares owned by the original shareholders and by VFI, which were increased by 50% as a result of the stock dividend.  This left the company with 27,500 authorized but unissued shares of common stock.  This unissued stock will prove to be very useful when BBE is presented with an investment opportunity, which we will learn about in a future blog.

Comments are always welcome.


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