The Central Trust Company and Albert E. Heekin, Jr., Co-Executors of the Estate of Albert E. Heekin, Deceased v. The United States. Katharine Heekin Herrlinger, James R. Heekin, Jr., and the Central Trust Company, Executors Under the Will of James J. Heekin, Deceased v. The United States. The Central Trust Company, Successor and Trustee Under the Will of Alma R. Heekin, Deceased v. The United States

These cases were referred by the court, pursuant to Rule 45, Rules of Court of Claims, 28 U.S.C., to Saul Richard Gamer, a trial commissioner of the court, with directions to make findings of fact and recommendations for conclusions of law. The commissioner has done so in a report filed April 17, 1962. Plaintiffs in case No. 196-58 filed their notice of intention to except to the commissioner's findings and recommendations on May 2, 1962, and on June 18, 1962, moved to withdraw this notice. Plaintiffs in case No. 199-58 and case No. 200-58 filed their notices to except to the commissioner's findings and recommendations on May 1, 1962, and on June 13, 1962, moved to withdraw these notices. On June 15, 1962, the defendant filed its reply advising the court that it had no objection to the withdrawal of the notices and on June 22, 1962, the court allowed plaintiffs' motions to withdraw the notices of intention to except in all three cases.

Plaintiffs in their motions to withdraw their notices of intention to except also moved, pursuant to Rule 46(a), that the court adopt the commissioner's report as the basis for its judgment in the cases. Defendant's reply filed June 15, 1962, concurred in these motions. Since the court agrees with the recommendations and findings of the commissioner, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in these cases. Plaintiffs are therefore entitled to recover and judgment is entered to that effect. The amounts of recovery will be determined pursuant to Rule 38 (c).

It is so ordered.

These suits are for the refund of federal gift taxes. They involve the common question of the value of shares of stock of the same company. A joint trial was therefore conducted.

On August 3, 1954, Albert E. Heekin made gifts totaling 30,000 shares of stock of The Heekin Can Company. The donor had formerly, for 20 years, been president of the Company and at the time of the gifts was a member of its board of directors. The gifts were composed of 5,000 shares to each of six trusts created for the benefit of his three sons, each son being the beneficiary under two trusts. Following his death on March 10, 1955, the executors of his estate filed a gift tax return in which the value of the stock was fixed at $10 a share. On October 28, 1957, however, they filed an amended gift tax return and a claim for refund, contending that the correct value of the Heekin Company stock on August 3, 1954 was $7.50 a share.

On October 25, 1954, James J. Heekin made gifts totaling 40,002 shares of Heekin Can Company stock. This donor, a brother of Albert E., had also formerly been, for 23 years, the president of the Company and at the time of the gifts was chairman of the board. The gifts were composed of 13,334 shares to each of three trusts created for the benefit of his three children and their families. Separate gift tax returns with respect to these (and other) gifts were filed by both James J. Heekin and his wife, Alma (who joined in the stock gifts), in which the value of the stock was similarly declared to be $10 a share. However, on January 21, 1958, James filed an amended gift tax return and a claim for refund, also contending that the correct value of the stock on October 25, 1954, was $7.50 a share, and on the same day, the executor of Alma's estate (she having died on November 9, 1955) filed a similar amended return and claim for refund.

On February 5, 1958, the District Director of Internal Revenue sent to James J. Heekin and the executors of the estates of Alma and Albert E. Heekin notices of deficiency of the 1954 gift taxes. Each of the three deficiencies was based on a determination by the Commissioner of Internal Revenue that the value of the Heekin Company stock on the gift dates was $24 a share.

Consistent with his deficiency notices, the District Director, on May 15, 1958, disallowed the three refund claims that had been filed, and in July 1958 payment was made of the amounts assessed pursuant to the deficiency notices. After the filing in August and September 1958 of claims for refund concerning these payments, the claims again being based on a valuation of $7.50, and the rejection thereof by the District Director, these three refund suits were instituted in the amounts of $169,876.19, $95,927.08, and $94,753.70 with respect to the Albert E. Heekin, James J. Heekin and Alma Heekin gifts, respectively, plus interest.

The Heekin Can Company is a well-established metal container manufacturer in Cincinnati, Ohio. In 1954, the year involved in these proceedings, its principal business consisted of manufacturing two kinds of containers, its total production being equally divided between them. One is known as packer's cans, which are generally the type seen on the shelves of food markets in which canned food products are contained. The other is referred to as general line cans, which consist of large institutional size frozen fruit cans, lard pails, dairy cans, chemical cans, and drums. This line also includes such housewares as canisters, bread boxes, lunch boxes, waste baskets, and a type of picnic container familiarly known by the trade names of Skotch Kooler and Skotch Grill. On the gift dates its annual sales, the production of five plants, were approximately $17,000,000.

The Company was founded in 1901 in Cincinnati by James Heekin, the father of the donors Albert and James. In 1908, it built a six-story 250,000 square foot factory in Cincinnati, which is still its headquarters and one of its main operating plants, producing general line cans. In 1917 it acquired a plant in Norwood, a suburb of Cincinnati, which has since become entirely surrounded by the city, and entered the packer's can business. By 1954, it was a multi-story plant with about 275,000 square feet, having grown irregularly throughout the years, one section having four floors, another three, and another only one.

In 1946, the Company branched out from Cincinnati and established a packer's can plant at Chestnut Hill, Tennessee, on property leased from and contiguous to the plant of its largest customer, which used the entire output of the Heekin plant. The cans were run by conveyor directly into the customer's packing plant.

In 1949, the Company built a 100,000 square foot plant in Springdale, Arkansas, to supply its customers in the Ozark area on a more competitive basis concerning freight costs, a large part of which, under the industry's freight-equalization practice, it had theretofore absorbed.

In 1952, the Company established its fifth plant, constituting an operation at Blytheville, Arkansas, similar to the one at Chestnut Hill, Tennessee. The plant was on leased property adjacent to the customer's plant, with the cans running directly into such plant. By 1954 this concept of installing can-making lines immediately adjacent to customers' packing plants was a recognized practice in the industry. Thus, the Company was progressively adapting itself to the modern practices of its industry.

From the beginning, the Heekin family has dominated the enterprise. James, the founder, was its president from 1901 to 1905. He was succeeded by his son, James J., one of the donors herein, who served as president for 23 years. In 1928, another son, Albert E., another donor herein, then became president, serving for 20 years. He was succeeded in 1948 by still another son, Daniel M., who served for 6 years. In March 1954, Albert E. Heekin, Jr., the son of donor Albert E. and the grandson of the founder, succeeded to the presidency. A lawyer, he had served the Company up to 1950 as its legal counsel, joining the Company in that year as assistant to the president. On August 3, 1954, of the ten-member board of directors, eight were members of the Heekin family, five of whom were sons of the founder, and three his grandsons. Both donors were members of the board, James J. being chairman. On October 25, 1954, the board was similarly constituted, except for the death of one son in August. Despite this family domination, there was no indication on the gift dates that the enterprise was not capably managed or that salaries were in any way excessive.

On the gift dates, the Company had 254,125 shares of common stock outstanding, there being no restrictions on their transferability or sale. There was no other class of stock. Including the 70,002 shares involved in these cases, a total of 180,510 shares were owned by 79 persons who were related to James Heekin, the founder. Thus, the Heekin family owned approximately 71 percent of all of the outstanding stock. The remaining 73,615 shares were owned by 54 unrelated persons, most of whom were employees of the Company and friends of the family.

Six major customers accounted for almost one-half of Heekin's 1954 business. Relations with these important customers were long-standing and excellent. One of these customers, the Hamilton Metal Products Company, which placed over $2,000,000 worth of business with Heekin in 1954, and for whom Heekin manufactured the Skotch Kooler and Grill, had, prior to the gift dates, advised Heekin of its need for certain new products, and on August 3, 1954 (one of the gift dates), Heekin's board of directors authorized the expenditure of approximately $90,000 for new tooling and equipment at its Cincinnati plant for the manufacture of such products. Another major customer was the Reynolds Tobacco Company, which placed almost $1,500,000 of business with Heekin in 1954 and with whom Heekin had dealt since 1908.

As indicated, freight costs play an important part in Heekin's business. These costs are significant in two aspects. One is the cost of transporting raw material to Heekin's plants. In this respect Heekin was quite favorably located. It has a dock on the Ohio River in Cincinnati, permitting it to take advantage of inexpensive water transportation of steel shipped from Pittsburgh, with a consequent advantage over some of its competitors in the same area who receive their raw materials by rail. The other important freight aspect is, as above noted, the cost of shipping the final product to the customer, and which factor motivated the establishment of its Springdale, Arkansas, plant. The Hamilton Metal Products Company was located only 25 miles from Cincinnati, giving Heekin an important freight advantage. And also, on August 3, 1954, Heekin's board of directors authorized the expenditure of about $650,000 for new tooling, machinery and equipment for its Norwood plant so that Heekin could enter the new field of manufacturing beer cans. At that time no other company in the Cincinnati area was engaged in the production of such cans, and Heekin concluded that, with the freight advantage it would have over its competitors in serving the brewers of the Cincinnati area, a profitable new source of business would be developed.

In 1954, favorable economic conditions generally prevailed in the can-manufacturing industry, and demand was at a record level. Indeed, this was the condition throughout the container and packaging industry, and optimism generally prevailed about the continuation of the then current high demand.

But Heekin had its problems too. It is a relatively tiny factor in a highly competitive industry dominated by two giants, the American Can Company and the Continental Can Company. In 1954, these two companies, each with over $600,000,000 of annual sales produced from 76 and 40 plants respectively, together accounted for about 75 percent of the country's total can sales. Three other can manufacturing companies, the National Can Corporation, the Pacific Can Company, and Crown Cork & Seal Co., Inc., together made about 8 percent of the sales. Heekin, with its five plants, did a little less than 1 percent of the total business. Prices in the can-making industry are for practical purposes established by American and Continental. When they announce prices, Heekin goes up or down with them. Unable to compete on a price basis, Heekin strives to give its customers better personal service, which, because it is smaller and closer knit, it can frequently do.

Probably Heekin's major problem is the age, and the resulting relative inefficiency, of a large part of its plant and equipment, and its inability to finance a large-scale program of modernization. This again is in part a problem of its small size. The relatively small amounts it can use for this purpose are generated by retained earnings, and it has consequently fallen behind the giants of the industry in erecting efficient plants and installing modern, high-speed, automatic can-making lines. During the war, Heekin was unable to buy new equipment. However, such competitors as American, Continental, and Pacific manufactured their own can-making equipment and were able to forge ahead, and such equipment as Heekin was able to buy after the war from other companies could not match American and Continental's modern automatic packer's can equipment, which produced 500 cans a minute. Heekin's older packer's can equipment could turn out only about 300 cans a minute, and even the new equipment it was able to buy after the war could attain, with difficulty, speeds of only 400 cans a minute. In 1954, about 90 percent of Heekin's equipment had been acquired in the middle 1930's or prior thereto. In all its plants, the Company had 37 can-making lines, 11 of which were very old and still hand operated.

Similarly, Heekin's Cincinnati and Norwood multistory plants, which accounted for about 75 percent of Heekin's total 1954 production, were less efficient than modern, single-story buildings. The can-making business is primarily a material-handling one, requiring a rapid and efficient flow of large amounts of material through the plant, from the receipt of the raw materials to the shipment of finished products. In a single-story building, materials can freely be moved horizontally with fork-lift trucks and conveyors, whereas in its six-story Cincinnati and four-story Norwood plants, elevators are used for the vertical movement of materials, resulting in excessive labor and handling costs and more difficult production controls. The proceeds of a $3,000,000 long-term loan which Heekin secured in 1950 were for the most part not available for such a plant and equipment modernization program.

However, the competitive disadvantage of lack of modern equipment was reflected more on the packer's can phase of its business than on the general line cans, which are produced both by Heekin and its competitors on only semiautomatic equipment. Such equipment does not lend itself as readily to the speed and automation required with respect to packer's cans. Heekin's semiautomatic lines were capable of producing around 300 cans a minute.

The Heekin stock was not listed on any stock exchange, and trading in it was infrequent. There was some such activity in 1951 and 1952 resulting from the desire of certain minority stockholders (the descendants of a partner of James Heekin, the founder) to liquidate their holdings, consisting of 13,359 shares. One individual alone had 10,709 shares. Arrangements were privately made in early 1951 by these stockholders with Albert E. Heekin and his son, Albert E. Heekin, Jr., to sell these holdings at the prearranged price of $7.50 a share. These shares were all sold, commencing March 22, 1951, and ending April 16, 1952, in 44 separate transactions, 35 of which took place in 1951 and 9 in 1952. No attempt was made to sell the shares to the general public on the open market. All sales were made to Heekin employees and friends of the Heekin family at such $7.50 price. Other than these 1951 and 1952 sales, the only sales of stock made prior to the gift dates consisted of one sale of 100 shares in 1953 by one Heekin employee to another, and one sale in 1954 of 200 shares, again by one Heekin employee to another, both sales also being made for $7.50 a share.

Against these background facts, the valuation question in dispute may be approached. Section 1000 of the Internal Revenue Code of 1939 (26 U.S.C. 1952 Ed., § 1000, 53 Stat. 144), the applicable statute, imposed a tax upon transfers of property by gift, whether in trust or otherwise. Section 1005 provided that "If the gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift."

Section 86.19(a) of the Regulations issued with respect thereto (Treasury Regulations 108, 8 Fed.Reg. 10858) defines such property value as the price at which the property "would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell. * * * Such value is to be determined by ascertaining as a basis the fair market value at the time of the gift of each unit of the property. For example, in the case of shares of stock * * *, such unit of property is a share * * *. All relevant facts and elements of value as of the time of the gift should be considered." With respect to determining the fair market value per share at the date of the gift, subsection (c) (6) stated that, if actual sales or bona fide bid and asked prices are not available, the value should be arrived at "on the basis of the company's net worth, earning power, dividend-paying capacity, and all other relevant factors having a bearing upon the value of the stock."

Further, a lengthy Revenue Ruling (54-77, 1954-1 Cum.Bull. 187), entitled "Valuation of stock of closely held corporations in estate tax and gift tax returns," was in effect at the time of these gifts which outlined "the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes." After warning in section 3 that fair market value, "being a question of fact," depends on the "circumstances in each case," and that "No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases," and that there is ordinarily "wide differences of opinion as to the fair market value of a particular" closely held stock, section 4 goes on to enumerate the following factors which "are fundamental and require careful analysis in each case": (1) the nature of the business and its history, (2) the general economic outlook of business in general and the specific industry in particular, (3) the book value of the stock and the company's financial condition, (4) the company's earning capacity, (5) its dividend-paying capacity, (6) its goodwill, (7) such sales of the stock as have been made as well as the size of the block to be valued and (8) "the market price of stocks of corporations engaged in the same or similar line of business which are listed on an exchange." After discussing each factor in detail, the Ruling goes on to consider such matters as (a) the weight to be accorded the various factors, concluding that, in a product selling company, primary consideration should normally be given to the earnings factor and (b) the necessity of capitalizing the earnings and dividends at appropriate rates.

There appears to be no dispute between the parties concerning the validity, or the propriety of applying the principles, of the Regulations and the Ruling to these cases. The dispute arises from the differences of opinion which are inherent in the Ruling's statement that "A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance."

Where, as in the present cases, the problem is the difficult one of ascertaining the fair market value of the stock of an unlisted closely held corporation, it is not surprising that, in assisting the court to arrive at an "informed judgment," the parties offer the testimony of experts. In such a situation, the opinions of experts are peculiarly appropriate. Bader v. United States, 172 F.Supp. 833 (D.C.S.D.Ill.). At the trial, the taxpayers produced three experts, and the Government one.

One of plaintiffs' experts was the senior partner of a firm of investment bankers and brokers. He felt that the limited prior sales of the stock at $7.50 warranted the consideration of the other factors listed in the Revenue Ruling applicable to closely held corporations. There were four major factors which he considered in arriving at his conclusion. The first was book value. Utilizing the Company's balance sheet as of December 31, 1954 (a date subsequent to the gift dates), the book value came to about $33 a share. In this connection he noted that the Company's financial position at that time was sound, with a ratio of current assets to current liabilities of about 4.3 to 1. However, principally because of the age and multistoried inefficiency of the Company's two main plants at Cincinnati and Norwood, he reduced the book value factor by 50 percent. The second factor was earnings. The Company's audited annual statements for 1952, 1953 and 1954, which he accepted without adjustment, showed that the average of its earnings for these 3 years was $1.77 a share. He felt that, in the case of this Company, a price earnings ratio of 6 to 1 would be appropriate, but, recognizing that this was the most important factor, he weighted it to give it double value. The third factor was dividend yield. In said 3 years, the Company paid an annual dividend of 50 cents. Accepting this figure as the dividend the Company would be likely to pay in the future, he concluded that an investor would look for a 7 percent yield on this stock, and capitalized it on that basis. The fourth factor was the prior sales at $7.50. Adding and weighting these figures, he derived a value of $10.50 a share. However, because the stock was not listed on any exchange, and was closely held, with sales being infrequent, he discounted that value by 25 percent to reflect the stock's lack of marketability, and came out with an ultimate valuation of $7.88 a share.1 This is the value plaintiffs now rely on in these cases. This value was applied to the entire block of 70,002 shares and to both dates, a block which, he noted, would give a purchaser only a minority position. Considering the Revenue Ruling's suggestion to investigate "the market price of stocks of corporations engaged in the same or similar line of business which are listed on an exchange," this witness felt that there were no listed companies that could properly be compared with Heekin.

Plaintiffs' second expert, a certified public accountant who had experience in and was familiar with the principles involved in valuing stocks of closely held corporations, arrived at the somewhat higher valuations of $9.50 per share for the 30,000 shares given on August 3, 1954, and $9.65 for the 40,002 given on October 25, 1954. He recognized that the previous sales of the stock in 1951, 1952, 1953 and 1954 at $7.50 could not be determinative because, being all at the same selling price, they could not have reflected the month-to-month or year-to-year fluctuations of actual value, which was the problem herein involved. He concluded that that price was predicated primarily to give a yield of 6 2/3 percent based on an annual dividend rate of 50 cents, which the Company had paid each year from 1946 through 1954, except for a 1½-year period in 1950 and 1951. In 1950, the Company suffered extraordinary losses and dividends were suspended, and in 1951, only 25 cents was paid. Accordingly, he considered the situation appropriate for the application of the principles enunciated in the Revenue Ruling.

In so doing, he too concluded that the four major factors to be considered were earnings, dividend yield, book value, and the price of the prior sales. As to earnings, he computed, from the Company's audited statements for the years 1950-54, without adjustment, average annual earnings of $1.68. Using the comparative method of calculating price-earnings ratios of listed companies in the same or similar business and then correlating such results to Heekin, he selected 11 leading corporations in the container industry (only two of which, American Can and Continental Can, were can companies), and computed their average price-earnings ratio over the similar 5-year period at 10 to 1, with 1954 alone producing a ratio of 11.6 to 1 because of the rise in prices of container industry stocks in that year.2 However, he capitalized Heekin's 5-year average earnings of $1.68 at an earnings multiple of only eight times which he considered appropriate for a "marginal" company like Heekin. Since this produced a value of $13.44 based only on earnings, as of December 31, 1954, due to his using the figures for the full year 1954, he adjusted the figure to August 3, 1954, the first gift date, by reducing the figure by 14.1 percent, a figure derived by calculating the general rise in a relatively large group of certain other industry stocks between August 3 and December 31. Thus, on the basis of earnings alone, he calculated a value of $11.55 as of August 3.

As to dividends, this witness then calculated Heekin's average for the 5 years ended December 31, 1954, at 35 cents per share and capitalized that figure at 6 percent, which he considered to be appropriate in Heekin's case in view of the 5-year average dividend yield of 5.1 percent for the 11 leading companies in the container industry which he used as comparatives, and the even higher returns, on a 5-year average basis, afforded by general groups of leading industrials during that period. Thus, on the basis of a 6 percent dividend yield alone, he calculated a value of $5.83.

Using as factors the value figures derived as described on the bases of price earnings ($11.55) and dividend yield ($5.83) ratios, together with a book value figure of $33.23 as of December 31, 1954, and a $7.50 figure as the price of the prior sales, the witness then weighted these four factor figures, giving the earnings and dividend factors 40 percent each (i. e. each figure multiplied by 4), and the book value and prior sales figure 10 percent each (i. e. each figure multiplied by 1). This total figure was then reduced by 15 percent to reflect the stock's lack of marketability (which was equated to the underwriting cost of floating 30,000 shares) which, after dividing by the weight factor (10), gave the market price as of August 3 as $9.37,3 which he rounded out to $9.50.

Using the same criteria and method, the witness valued the 40,002 shares given on October 25, 1954, at the slightly higher price of $9.65, the price of listed stocks having generally risen between the two dates.

The taxpayers' third expert, a senior officer in a firm specializing in valuing the stocks of closely held corporations, came out with the still higher valuation of $11.41 per share on August 3, in blocks of 10,000 ($11.76 in a block of 30,000 shares). For the shares given on October 25, however, his value was only $9.40 per share in blocks of 13,334 shares ($9.47 in a block of 40,002 shares).

This witness also used the technique of selecting comparable companies traded on a national exchange, ascertaining, by a very comprehensive study, the relationship between their market prices and their earnings, "earnings paid out," and return on invested capital (to which he added long-term debt), and then correlating the data to Heekin. Unlike the other two experts, he did not accept the exact figures of the audited statements of annual earnings, but studied them with a view to detecting and eliminating abnormal and nonrecurring items of loss or profit in order to obtain a better picture of the Company's normal operation and of what an investor, therefore, might reasonably conclude the Company's future performance would be. With such adjustments and eliminations, he thus recasted the Company's earnings for the years 1949-1953. He selected eight companies in both the can and glass container fields to use as comparatives.

In calculating Heekin's earnings, the witness used a 5-year average, as adjusted. One of the adjustments was to the Company's abnormal profits in 1951 as a result of the Korean war, which he eliminated and reduced to more normal levels. Another was to eliminate, as abnormal and nonrecurring, rather large losses the Company suffered in 1950, 1951 and 1952 as a result of the operations of a subsidiary which was liquidated. By applying a price-earnings ratio of 11.82, as derived from the comparative companies, he determined a value of the Heekin stock on August 3, based only on earnings, of $13.78 per share; a value based on earnings paid out (in which he included not only dividends but also interest on long-term debt) on the capital invested in the business of $9.59 per share; and a value based on invested capital of $31.34 per share. To these three determinants of value, he added the fourth factor of $7.50 derived from the prior sales price. He too then weighted these figures, assigning a weight of 33 1/3 percent each to the values based on earnings and earnings-paid-out, and 16 2/3 percent each to the values based on invested capital and the prior stock sales. This gave a total weighted value of $14.26. He then too applied a 20-percent reduction for lack of marketability, which he also equated with flotation costs for blocks of 10,000 shares, resulting in the net figure of $11.41 as of August 3.4

The same technique produced a figure of $9.40 per share as of October 25, 1954, in blocks of 13,334 shares.5 This lower valuation is attributable to the drop in the market prices of the comparative companies between August 3 and October 25, 1954. One of the comparatives (Pacific Can Company) which had been used for the August 3 valuation was dropped since it enjoyed a rather atypical sharp rise after such date due to a proposed merger.

Various major criticisms can fairly be made of these three appraisals offered by plaintiffs. First, they all give undue weight as a factor to the $7.50 price of the prior stock sales. Almost all of these sales occurred in the relatively remote period of 1951 and early 1952. Only one small transaction occurred in each of the more recent years of 1953 and 1954. Such isolated sales of closely held corporations in a restricted market offer little guide to true value. Wood, Adm. v. United States, 89 Ct.Cl. 442, 29 F.Supp. 853; First Trust Co. v. United States, 3 Am.Fed.Tax R.2d 1726 (D.C. W.D.Mo.); Drayton Cochran v. Commissioner, 7 CCH Tax Ct.Mem. 325; Schnorbach v. Kavanagh, 102 F.Supp. 828 (D.C. W.D.Mich.). In an evaluation issue, this court recently even gave little weight to the sale of shares on a stock exchange when the amount sold was "relatively insignificant." American Steel Foundries v. United States, Ct.Cl. No. 197-54, decided April 7, 1961 (slip opinion, p. 4). To the same effect is Heiner v. Crosby, 24 F.2d 191 (C.C.A.3d) in which the court rejected stock exchange sales as being determinative and upheld the resort to "evidence of intrinsic value" (p. 194). Furthermore, the $7.50 price of the 1951 and 1952 sales evolved in early 1951 during a period when the Company was experiencing rather severe financial difficulties due to an unfortunate experience with a subsidiary which caused a loss of around $1,000,000, and when, consequently, the Company found itself in a depleted working capital position and was paying no dividends. Further, there is no indication that the $7.50 sales price evolved as a result of the usual factors taken into consideration by informed sellers and buyers dealing at arm's length. Fair market value presupposes not only hypothetical willing buyers and sellers, but buyers and sellers who are informed and have "adequate knowledge of the material facts affecting the value." Robertson v. Routzahn, 75 F.2d 537, 539 (C.C.A.6th); Paul, Studies in Federal Taxation (1937), pp. 193-4. The sales were all made at a prearranged price to Heekin employees and family friends. The artificiality of the price is indicated by its being the same in 1951, 1952, 1953 and 1954, despite the varying fortunes of the Company during these years and with the price failing to reflect, as would normally be expected, such differences in any way.

Secondly, in using the Company's full 1954 financial data, and then working back from December 31, 1954, to the respective gift dates, data were being used which would not have been available to a prospective purchaser as of the gift dates. "The valuation of the stock must be made as of the relevant dates without regard to events occurring subsequent to the crucial dates." Bader v. United States, supra, 172 F.Supp. at p. 840. Furthermore, in the working-back procedure, general market data were used although it is evident that the stocks of a particular industry may at times run counter to the general trend. This was actually the situation here. Although the market generally advanced after August 3, 1954, container industry stocks did not.

Thirdly, the converse situation applies with respect to the data used by the third expert. His financial data only went to December 31, 1953, since the Company's last annual report prior to the gift dates was issued for the year 1953. But the Company also issued quarterly interim financial statements, and by the second gift date, the results of three-quarters of 1954 operations were available. In evaluating a stock, it is essential to obtain as recent data as is possible as section 4 of the Revenue Ruling makes plain. Naturally, an investor would be more interested in how a corporation is currently performing than what it did last year or in even more remote periods. Although the use of interim reports reflecting only a part of a year's performance may not be satisfactory in a seasonal operation such as canning, it is possible here to obtain a full year's operation ending on either June 30 or September 30, 1954, which would bring the financial data up closer to the valuation dates.

Fourth, it is accepted valuation practice, in ascertaining a company's past earnings, to attempt to detect abnormal or nonrecurring items and to make appropriate eliminations or adjustments. As shown, only the plaintiffs' expert who came out with the highest August 3 valuation attempted to do this by adjusting the excessive Korean war earnings and by eliminating the unusual losses suffered in 1950, 1951 and 1952 arising from the operations of a financing subsidiary (Canners Exchange, Inc.) that had been liquidated in 1952. The reason this is important is that past earnings are significant only insofar as they reasonably forecast future earnings. The only sound basis upon which to ground such a forecast is the company's normal operation, which requires the elimination or adjustment of abnormal items which will not recur. Plaut v. Smith, 82 F. Supp. 42 (D.C.Conn.), aff'd., sub. nom. Plaut v. Munford, 188 F.2d 543 (Ct.App. 2d Cir.). In American Steel Foundries v. United States, supra, the court similarly viewed the "earning prospects" of the company whose stock was being evaluated in light of its past earnings "as constructed by the accountants, eliminating or adjusting losses due to strikes or other nonrecurring events." And the court in White & Wells Co. v. Commissioner, 50 F.2d 120 (C.C.A.2d), also held that: "* * * past earnings * * * should be such as fairly reflect the probable future earnings" and that to this end "abnormal years" may even be entirely disregarded. The Revenue Ruling (sec. 4.02(d)) specifically points out the necessity of separating "recurrent from nonrecurrent items of income and expense."

Fifth, in deriving a past earnings figure which could be used as a reasonable basis of forecasting future earnings, none of plaintiffs' experts gave any consideration to the trend of such past earnings. They simply used the earnings of prior years and averaged them. But such averages may be deceiving. Two corporations with 5-year earnings going from the past to the present represented by the figures in one case of 5, 4, 3, 2, and 1, and in the other by the same figures of 1, 2, 3, 4, and 5, will have the same 5-year averages, but investors will quite naturally prefer the stock of the latter whose earnings are consistently moving upward. The Revenue Ruling specifically recognizes this in providing (sec. 4.02(d)) that: "Prior earnings records usually are the most reliable guide as to the future expectancy, but resort to arbitrary five-or-ten-year averages without regard to current trends or future prospects will not produce a realistic valuation. If, for instance, a record of progressively increasing or decreasing net income is found, then greater weight may be accorded the most recent years' profits in estimating earning power."

And further, since the most recent years' earnings are to be accorded the greatest weight, care must be taken to make certain that the earnings figures for such years are realistically set forth. For instance, in Heekin's case, profits for 1952-54 were understated because a non-contributory retirement plan for hourly employees was established in 1951 for which the costs attributable to 1950 and 1951 were borne in the later years of 1952-54. Similarly, 1954 profits were further understated because they reflected (1) a renegotiation refund arising out of excess profits made in 1951, and (2) they were subjected to a charge of $174,203.54 ($83,617.70 after taxes) as a result of a deduction from 1954 profits only of certain expenses attributable to both 1954 and 1955. This abnormal doubling up of 2 years' expenses in one year was permitted by a change in the tax laws which became effective in 1954 (and which was later revoked retroactively) which allowed taxpayers such as Heekin to change their methods of accounting so as to effect the accrual in 1954 of these 1955 expenses. If proper adjustments are made in Heekin's 1954 statements for these items, the earnings for the 1954 period prior to the gift dates would be realistically increased and given due weight insofar as earning trends are concerned.

None of plaintiffs' experts made any of these adjustments in connection with a trend study or otherwise.

Sixth, it is generally conceded that, as stated by the Revenue Ruling, in evaluating stocks of manufacturing corporations such as Heekin, earnings are the most important factor to be considered. Bader v. United States, supra. Yet only one of plaintiffs' experts, who assigned double value to this factor, gave it such weight. As shown, the other two assigned the dividend factor equal weight. Some investors may indeed depend upon dividends. In their own investment programs, they may therefore stress yield and even compare common stocks with bonds or other forms of investment to obtain the greatest yields. However others, for various reasons, may care little about dividends and may invest in common stocks for the primary purpose of seeking capital appreciation. All investors, however, are primarily concerned with earnings, which are normally a prerequisite to dividends. In addition, the declaration of dividends is sometimes simply a matter of the policy of a particular company. It may bear no relationship to dividend-paying capacity. Many investors actually prefer companies paying little or no dividends and which reinvest their earnings, for that may be the key to future growth and capital appreciation.

And further, in capitalizing the dividend at 6 and 7 percent, as did two of the experts, rates of return were used which well exceeded those being paid at the time by comparable container company stocks. And still further, one of the experts used a 35-cent dividend rate as the basis for his capitalization because that was the average paid for the 5 years ended December 31, 1954. However, it seems clear that an annual dividend rate of 50 cents a share would be the proper rate to capitalize since that was the dividend paid by Heekin every year since 1945 except for the year 1950 and the first half of 1951 when, as shown, dividends were temporarily suspended. By the end of 1951 the Company had recovered from the situation causing the suspension and the normal dividend (quarterly payments of 12½ cents per share) was then resumed. By August and October 1954, Heekin's demonstrated earning capability and financial position were such that there was little doubt it would at least continue its 50-cent annual dividend, which represented only about 25 percent of its current earnings per share. To dip back into this 1950-51 atypical period to compute an "average" of dividends paid for the past 5 years is unrealistic.

Finally, the record indicates that all three experts took too great a discount for lack of marketability. Defendant disputes the propriety of taking this factor into consideration at all. It seems clear, however, that an unlisted closely held stock of a corporation such as Heekin, in which trading is infrequent and which therefore lacks marketability, is less attractive than a similar stock which is listed on an exchange and has ready access to the investing public. This factor would naturally affect the market value of the stock. This is not to say that the market value of any unlisted stock in which trading is infrequent would automatically be reduced by a lack of marketability factor. The stock of a well-known leader in its field with a preeminent reputation might not be at all affected by such a consideration,