The series, "The penny stocks of Kirkland Lake," has sparked some much-needed debate around the nature of stocks sold by profitless companies. In part two of the Kirkland Lake series, it was proposed that stocks sold by profitless firms might actually be more accurately described as options, giving buyers the right to equity in future profits.
The idea is that these newfangled options would convert to stock if the issuing company profited and that the stock of once-profitable companies would convert back to options, upon losing profitability. In order for this transformation to take place, the meaning of what a stock is would need to be changed.
This prompts the question: what is the legal definition of a stock?
It turns out, there isn't one. Referring to the U.S. Securities Act of 1933 and the Ontario Securities Act, the two most powerful pieces of legislation governing trading in North America, the words "stock" and "shares" are used to define the term "security," with no further explanation.
Stocks are created by people
However, stocks don't grow up out of the ground, with features that all of those whose lives they have touched over more than 400 years would agree upon. In fact, buyers of the first initial public offering of stock, in 1602, would likely hold their bellies, aching from laughter, if presented with some of the so-called stocks of today.
By examining this first IPO, compared with a TSX Venture Exchange stock of today, a clearer picture of the current situation may be gained.
The words shares and stock have deep roots in the first that were offered, by the Dutch East India Company, in 1602. Everyone that followed attempted to emulate their success. Also referred to as the VOC, the company was profitable and paid dividends, ranging from 12 to 63 percent, over its first seven years of existence.
Dividend yield over 10 percent
Who at the time, unfamiliar with the concept of stock, would buy paper with promises of share ownership without significant, regular cash payments (dividends) that could be counted upon? Dependable dividends yielding 12 to 63 percent today are unheard of.
Say the buyers of the 1602 VOC IPO were presented with shares, down 95+ percent, of Goldstar Minerals Inc.
(TSXV: GDM). The company pays no divided, generates no revenues, and reported per share losses of $0.07, $0.03, and $0.08, in 2015, 2014, and 2013, respectively.
"That's not a stock," one could easily imagine the 1602 investors observing. Compared with shares of the VOC, GDM shares appear almost comical. No one would buy them.
How is it then that Goldstar Minerals is actually able to find buyers? It is a result of the perception of people globally, over the course of 400 years. Over time, it became known that some people made fortunes with stocks. This perception made it easier for companies that paid lower dividends or that were less profitable to sell shares. Over time, this slide continued, to where companies without dividends and profits could sell stock.
Eventually we find the situation today: many firms issuing stock have no dividends, no profits, and no revenues.
Stock in profitless companies an absurdity?
Issuers of the first stock and their investors would not have called the security sold by Goldstar a stock. There is a body of academic work that makes a compelling case that dividends are unnecessary and may even hamper the ability of companies to operate and grow, which makes sense. However, the same research does not extend to profitless companies.
If the very first investors, who defined what stock is, wouldn't have accepted companies without profits, why should profitless companies be permitted to issue stock today? Wouldn't describing them as options or another novel instrument, giving the right to stock upon profitability, be a more fair and transparent way to describe profitless stocks, adding an extra layer of protection? Next, the features and benefits required of these proposed newfangled options will be discussed.
