Watered Stock

What Is Watered Stock?

Watered stock alluded to shares of a company that were issued at a lot greater value than the value implied by a company's underlying assets, ordinarily as part of a scheme to dupe investors. The last known case of watered stock issuance happened many years prior, as stock issuance structure and regulations have developed to put a stop to the practice.

This term is accepted to have originated from farmers who might make their dairy cattle drink large measures of water before taking them to market. The weight of the drank water would make the steers misleading heavier, enabling the farmers to get higher prices for them.

Understanding Watered Stock

The book value of assets can be overvalued in light of multiple factors, including inflated accounting values — like a one-time artificial increase in inventory or property value — or exorbitant issuance of stock through a stock dividend or employee stock-choice program. Maybe not in each and every case, but rather frequently in the late nineteenth century, owners of a corporation would make misrepresented claims about a company's profitability or assets, and knowingly sell shares in their companies at a par value that far surpassed the book value of the underlying assets, leaving investors with a loss and the fraudulent owners with a gain.

They would do this by contributing property to the company, in return for the stock of inflated par value. This would make the value of the company increase on the balance sheet, even however, in reality, the company would hold far less assets than those reported. It wouldn't be until a lot later that investors discovered that they were deluded.

Those holding watered stock found it challenging to sell their shares, and in the event that they could find purchasers, the shares were sold at much lower prices than the original price. On the off chance that creditors abandoned the company's assets, the holders of watered stock could be held at risk for the difference between the company's value on the books and its value in terms of real property and assets. For instance, assuming an investor paid $5,000 for stock that was just worth $2,000, he could find himself on the hook for the $3,000 difference on the off chance that the creditors dispossessed corporate assets.

Daniel Drew, dairy cattle driver and financier, is credited with introducing the term watered stock to the finance world.

The End of Watered Stock

This practice basically reached a conclusion when companies were constrained to issue shares at low or no par value, as a rule under the counsel of lawyers who were mindful of the potential for watered stock to make liability for investors. Investors became careful about the commitment that par value of a stock addressed the real value of the stock. Accounting guidelines developed so the difference between the value of assets and low or no par value would be represented as capital surplus or additional paid-in capital.

In 1912, New York allowed corporations to legally issue no-par-value stock and split the incoming capital between capital surplus and stated capital on accounting ledgers, with different states following suit presently.

Highlights

• Watered stock is issued at a higher value than it is really worth; it is achieved by overstating the company's book value.
• Watered stock is an unlawful scheme to dupe investors by offering shares at misleading high prices.
• Watered stock, once revealed for what it is, becomes hard to sell, and on the off chance that sold, is regularly done so at a much lower price than originally obtained.