In addition, there are related problems which concern the surplus and reserves. It is true, these all have their origin in the general considerations of valuation as given for the assets and liabilities. But questions as to what constitutes a profit, whether all profits are applicable to dividends, the proper treatment of capital profits, the relation of capital losses to profits and dividends, the differentiation of the classes of reserves, and finally the manner of showing and explaining the periodic changes in net worth by means of the supplementary statement of profit and loss—all these and other similar questions are closely related to the problem of valuation and, as indicative of the financial policy of a business, may directly affect all going concern values. On this account they require separate treatment from that of any individual assets and liabilities or group of assets and liabilities. Accordingly, the next few chapters will be concerned with these problems and any others which are relevant thereto.
Kinds of Stock
Capital stock is of various kinds—that with a stated par value and that without, common stock, various kinds of preference shares, debenture stock, guaranteed stock, founders’ stock, convertible stock, and redeemable stock. The student is referred to [Chapter I] where these various kinds of stock are discussed.
Par, Real, and Market Values
Capital stock may have several kinds of value, as the term value is used. All stock is expressed as so much per share. The value mentioned as the stated value of a share of stock in the contract of issue is known as the par, face, or nominal value.
The book value of stock is the value of the stock, as shown by the books—not the amount carried in the stock accounts, but the entire net worth of the corporation divided by the number of shares outstanding. Thus, if the assets minus the liabilities—the net assets—of a corporation amount to $1,500,000, of which $1,000,000 represents 10,000 shares of stock of par value $100, and the $500,000 is surplus, the book value of the stock is said to be $150 per share. From the standpoint of a going concern, this value is also spoken of as the real value in the sense that it is represented, dollar for dollar, by actual assets held by the corporation. Real value is also used to mean liquidation value, the value which the net assets upon forced or voluntary sale would realize for distribution to each shareholder.
Finally, there is the market value of stock by which is meant the value placed on it in the stock market or wherever stocks are dealt in. This value depends primarily upon the dividend-earning capacity of the stock, although many side issues of fact and opinion affect it. Thus, not only present, but past as well as prospective future dividends influence the market. At times, particularly in a declining market, the financial needs of the holders of the stock may affect prices more than the dividend rate of the stock.
The problem of stock valuation as related to the commercial balance sheet takes cognizance of only one of these values, viz., par value, though each of the others is related to and measured by the showing of values on the balance sheet. That par value is not always the true value cannot be controverted. As already shown, the inclusion on the balance sheet of assets of doubtful value is allowed when the doubtfulness of their value is generally recognized and no one is thereby misled. Some problems in connection with stock values and their inflation on the books will now be discussed.
Value Dependent upon Earning Capacity
Upon the inception of an enterprise the problem of stock valuation is always bound up with the question of valuation of the assets and liabilities, as pointed out above. When the asset to be valued is only cash, the problem is not usually difficult, as where the capital stock is sold for cash. Where, however, the sale is for a property taken over, the valuation of the stock is related to the larger problems of capitalization, with which in turn the valuation of the assets is bound up. It seems best, therefore, for an intelligent understanding of the question to review briefly some of the bases of capitalization.