Why buy stocks that don't pay dividends?

Factual Questions
41

[QUOTE=scotandrsn]
Look, I don’t know how much clearer I can make this. It’s not as though I’m down on stocks. I have a 401K that invests in them. I’m just trying to understand.

A company issues stock, and I buy it. Part of the assets of the company are mine. I also own my share of any profit the company shows. I get it.

If, as the company becomes profitable, and I’m twiddling my thumbs waiting for the company’s managers to decide how much of the profit will be released as dividends and how much will be re-invested in operations, I notice another soul who wants part of the profits, and is willing to pay more than I did for some shares because the company is more profitable, an amount which is more than my likely dividend, it may make more financial sense in certain cases for me to simply sell my shares to that person and go on my merry way. I get that too.

It may in fact be the case that my motivation for buying in the first place was that I anticipated being able sell higher, and that may be the motivation of my buyer as well. I get that too. But I emphasize that the desire to get a share of the profits is not gone, it is simply projected onto some future potential buyer.

Until we get to the case where the company never releases dividends, and every single person transacting shares of that company is aware that it has not happened and is not likely to. Once we get there, it’s turtles all the way down, and the company’s name may as well not be on any paperwork, because without someone’s belief that they will eventually share in it, any connection between the price of the stock and the company’s profitability (a conecpt repeated umpteen times in this thread, yes I read it) is illusory, a selling point to catch suckers, IMO. It’s simply people buying a worthless piece of paper on the gamble that they can find someone dumb enough to pay even more for it.

I thank WoodenTaco for making the first post I’ve read in this or any similar thread that admits to this, although even a “house of cards” is built on something, unlike the scenario above.

But I would be the first to admit I don’t know anything about this, which is why I put forth the example of someone paying high just before the stock price tumbles, simply to show that there must be a bottom this thing, a last buyer who can not expect to profit from the sale of the shares. Either that person knew they couldn’t turn a profit and knows some way that I don’t know of other than dividends to profit from owning a piece of a company that does not issue them, or they didn’t know and the whole business of buying and selling shares in a company that does not pay dividends is just a big game of hot potato, and the highest paying buyer is simply the one who loses.

So I’m just trying to understand, which is it? I think WoodenTaco has gven me the answer.
[/QUOTE]

There is no “last buyer” unless the company folds. This will eventually be the case but if that is 5 billion years from now when the sun flames out, it isn’t a major factor right now.

It seems like you are stuck on the idea that absent a dividend, your shares only represent a hope that a bigger sucker will come along. This is wrong on two counts: First, the next buyer is not necessarily a sucker. If you have chosen a good stock, it will continue to increase in value indefinitely. Second, as pointed out many times above, it’s rise in value while you hold it is greater if it does not pay a dividend. Every time a company pays a dividend its intrinsic worth is diminished by the cash amount required to pay the dividend.

Finally, if you are just really stuck on the value of getting your dividend, choose your own dividend amount and pay it to yourself by liquidating an amount of your stock equivalent to the amount you think the dividend should be. If you have $100,000 worth of stock and want a 5% dividend, liquidate $5,000 worth of your stock every year. In the best scenario, you will never run out of stock. With other stocks, you might eventually liquidate all of it. It pretty much amounts to the same thing, though, and even though you are choosing to “pay” yourself the dividend, it amounts to the same thing as the company paying it. The 'intrinsic value" of your residual share of the company after you take out your “dividend” is reduced by the amount of that dividend every time you pay it to yourself and the ability of the remaining portion to generate income is equally diminished.

42

Anyone thinking that there are reasons for value beyond the market should think about the cause for wild fluctuations in the price of a stock when the basics haven’t changed much. There are lots of ways of calculating what the value should be, but the bottom line is that it is what it is.

In the old days, a stock like AT&T wouldn’t change value very much, and it was considered a widows and orphans stock - good for dividends. However, that changed even 25 years ago. When I worked for AT&T I foolishly had half my 401K in AT&T stock, and as it turned out I made a lot more from stock value increase than I did from dividends.

43

Iapologize for not reading every single answer, but I read an awful lot of them before I ran out of time. So if I am repeating the thoughts of another, forgive me and ignore.
First, Google is a unique situation and drawing parallels from it is probably a waste of time.
Second, (please correct me if I am wrong anywhere - just my opinion) if a stock’s price did not reflect it’s value as a profit making enterprise, those with sufficient financing could take over the company and keep all of the profit for themselves. One can still do this of course but with stock selling at a large multiple of earnings this happpens infrequently, but it does happen witness, Kirk Kerkorian, Boone Pickens, Carl Icahn etc.
Third, even though there may be no dividends in the near future the stock price is often the most important item on the CEO’s mind as he tries to connive and finagle a way to get that price up so he can exercise his warrants and bonuses to maximum advantage (often without any long-term benefit to shareholders.)

44

Sorry to pull this thread out of the rubbish bin where it’s apparently been laid to rest, but I still haven’t seen a good answer. First of all, please understand that I know how the market works - in fact, I have spent the majority of my professional career working in the banking, equities or fixed income business. But stocks still seem to be turrtles all the way down (great quote, that). Let’s contrast stocks with some other investments, shall we?

Bonds - when you buy a bond you are purchasing debt; that is, you are loaning money to an entity with a promise that it will be paid back (with interest) either on a regular basis or in one lump sum at maturity (as with zero coupon bonds).

Metals - there is intrinsic value here - the material has industrial use

Futures - same here, even though the contracts are just paper, the underlying material will be put to use by someone

Stamps/coins - personally I don’t get this, but there is apparently a sizeable percentage of the population that is willing to pay money for the pleasure of owning these commodities

Real estate - the property has definite utility - you can live in it, rent it out, or develop it and then sell the improved property for more money.

Art - similar to stamps and coins - you can derive pleasure from owning the artwork while it appreciates in value

Stocks - don’t fall into any of these categories…you can’t develop a stock, live in it or rent it (except for securities lending, and let’s not get into that right now); there’s no intrinsic pleasure in owning it, and even if the stock does pay dividends, it’s not nearly comparable to what bonds pay.

So where’s the value?

45

You’re kidding, right? People buy collectibles just for the pleasure of owning them and never just for the speculative worth of their future appreciation in value? Gold is bid up just because it’s used by dentists and never because people think the economy is going to collapse? Futures are different from stocks because futures represent tangibles and stocks don’t represent an actual fractional ownership of an actual company? Stocks aren’t comparable to what bonds pay even though they have a higher rate of return in all eras of history except for a few short recessions?

“Working in the banking, equities or fixed income business” as a janitor doesn’t count, you know.

46

[QUOTE=morgantire]
If a stock doesn’t pay dividends, then what connection does it have to the profits of the underlying company? Maybe that company’s profits are going up or down, but either way, your non-dividend-paying stock doesn’t let you get any share of that profits.

[/QUOTE]

Sure you do. Your profit comes in the form of the stock’s rise in market price, or ideally that’s the way it works. The dividend itself may only be a small portion of that rise. I believe this is why you may receive a dividend even if the company lost money that quarter.

47

Naughty Harpo! But seriously, a heckuva lot of art bought as investment never sees the outside of a bank vault - keeping a really valuable painting on display is a serious risk for a number of reasons. So then you’re left with the cosy feeling that you have the Mona Lisa in your bank vault, or the last 1933 threepenny bit, or whatever… and how is this more of a pleasure, let alone economically viable, than a certificate demonstrating that you own 1% of all of United Widgets’ assets?

48

There’s one question here that is answered satisfactorily: it should be clear that a company that pays a dividend and a company that holds onto money that could be paid as a dividend, but instead becomes a factor in that company’s value are equal investment vehicles, essentially.

Then, there’s another question in this thread.

Imagine if a company came out tomorrow and said, “we’re never going to pay a dividend ever from here to eternity”, then a person buys that stock based solely on the belief that someone will pay more for it later.

Obviously, the price of it is tied to a company’s value. But, you’re just buying that stock based on the assumption that future man will also want to also purchase a “thing” tied to a company’s value.

Pretend to go back in time to when the first stock was issued. Someone said to you, “buy a part of my company”.

“What’s in it for me?”

“Well, I’ll give you a share of the profits or maybe someday the company gets bought, or decides to close its doors and we’ll return to you your portion of the proceeds. Also, we’ll give you the option of selling that share to future man who then receives the same deal, a promise of profits or liquidation value.”

What some people in the thread are saying is that with a company like MSFT or GOOG or even IBM, we’ve removed ALL the incentive to buy the stock, but future man is still out there. We’ve removed the dividend, and we’ve removed the liquidation value. There’s nothing left except the option to sell it, but all you’re selling is a representation of some unrealizable value.

I don’t think that the question “why buy stock that doesn’t pay dividends” gets at that, though.

49

No, at most that’s only true in the short term. It does not preclude the possibility that the company will be profitable in the future, or that it will issue dividends in the future, or that it will become sellable in the future, or that the company will buy back its stock in the future, or anything at all about the future.

That’s why I keep harping on the future. Many things are possible in the future. Nothing is guaranteed. The purchase of a stock is a risk because the future is unknown. To offset the risk, the company makes an implicit promise to offer a return on the investment that the sale of a stock represents. Sometimes that works, sometimes not. However, the risk is always there, for every company, no matter whether they currently pay dividends or currently make a profit. There is no guarantee they will continue to do so tomorrow. Any purchase of any stock is a risk. What you have to ask yourself is what level of risk are you willing to take? That answer will vary, not just for every individual, but for every time period.

And the Greater Fool theory works wonderfully. Unless you’re the last fool. Even so, the rest of the population is much better off. So even in your impossible hypothetical world:

it can still be a rational act to buy the stock today. Risky, to be sure. But rational.

And nobody can possibly know when it becomes irrational until it actually does.

That’s why this talk of turtles all the way down is so silly. There can be an infinite numbers of transactions before that one ending. Each one rests on an equally firm foundation. That foundation is assumption of risk, which is built into every single stock purchase of whatever type.

The short way to answer the OP, therefore, is that all stock purchases are nothing but the assumption of risk. Are dividend-free stocks inherently more risky than those that pay dividends? No. Are they sometimes more risky? Yes. Should you expect to get a greater return in stock price to compensate you for that risk? yes. Will you? Nobody knows.

That’s all there is to it. No turtles involved.

50

[QUOTE=Trunk]
Imagine if a company came out tomorrow and said, “we’re never going to pay a dividend ever from here to eternity”, then a person buys that stock based solely on the belief that someone will pay more for it later.
[/QUOTE]
You’re right: if you’re certain a company will never, ever, ever pay a dividend (and won’t dissolve with a positive value), then you should not rationally pay for the stock, unless you believe a bigger fool will come along. But companies never do say that they plan to be in business forever, and not pay dividends. They just say that they’re not going to pay dividends soon.

And that’s completely different. Even if the dividends are far in the future – far after you plan on selling the stock – you can still invest in them, because the promise of future dividends is still valuable to someone else.
Of course the other way to get value out of a company’s shares is if the company goes out of business (either gets bought, or sells off all of its assets and has something left over after paying its debts). For instance (I don’t know how reasonable this is in the real world, but the theory is fine), imagine a company formed solely to build and then sell one office tower. After the tower is sold, the company’s only assets are cash, and it dissolves itself and divides the assets (cash) among its shareholders. The shareholders never get dividends, but they do get money back (hopefully more than they invested), and therefore the shares are worth buying.

51

Right. Like the Queen’s ability to dissolve the government, the possibility that Google will pay dividends that are worth what a share is valued at or that it will liquidate and divide up its assets (and just the name “Google” is a pretty valuable asset!) is real and important, even if it is mostly theoretical. It might be true that every turtle is standing on the back of another turtle (an even bigger fool), but they are at least leaning on those possibilities, which keeps the market (somewhat) rational.

52

[QUOTE=Exapno Mapcase]
You’re kidding, right? People buy collectibles just for the pleasure of owning them and never just for the speculative worth of their future appreciation in value? Gold is bid up just because it’s used by dentists and never because people think the economy is going to collapse? Futures are different from stocks because futures represent tangibles and stocks don’t represent an actual fractional ownership of an actual company? Stocks aren’t comparable to what bonds pay even though they have a higher rate of return in all eras of history except for a few short recessions?
[/quote]

No, I’m not kidding. There are enough people willing to pay for art/collectibles AS collectibles to keep the market up. Can’t really respond to your point on gold, but my point on futures was that after the contract becomes due, you have left behind the material on which the contract was written, which will then be put to use. As a stockholder, you STILL can’t use your fraction of the company for anything. And yes, I’m aware that the return on bonds has historically been lower than that on stocks; however, that is still missing the point of this question.

Thanks for your vote of confidence. I’m in technology, so having a working knowledge of the business is a requirement.

OK, let me try to word this question another way.

Suppose I buy 100 shares of MSFT for $30 each, or $3000 total. With a market cap of $290B, I think we can all agree that they’re not going to be a takeover target in the foreseeable future.

Three months goes by, a good earnings report comes out, and I sell my shares to A for $35 each, or $3500. I’ve made 500 (less commission, but let's ignore that). Microsoft's dividend is currently .40/yr (percentage wise, a very low rate of return, and obviously not a good reason [in and of itself] to own the stock), so add on another $10.00 profit. Another three months goes by and they have another good earnings report. A sells his shares to B for $4500 and makes $1000. B sells to C, C sells to D, and the cycle continues, ad infinitum. At some point in this chain, there has to be someone who wants the stock for the purpose other than to sell it to some other party. What is that purpose?

53

How does a stock certificate differ from a $1000 bill - which just represents a tiny stake in Uncle Sam, Inc? It’s not backed by gold and hasn’t been for ages.

54

Making computer software. You own a tiny fraction of the company, including all of its tangible and intangible assets. This took me a while to grasp as well. You (the collective shareholders) could decide to dissolve the company and divvy up the value of the assets after selling them off. MS has a lot of assets, including its many and extremely valuable trademarks, which are valued because MS has developed a reputation as THE leader in computer software development and marketing. The rights to the software it has already developed are also extremely valuable. If the company was dissolved, those assets would likely bring in a substantial portion of the market cap, of which you would get your share.

It is extremely unlikely that the shareholders would dissolve MS, because the company is worth far more if it continues making computer software. It has huge numbers of very talented employees (and presumably an even larger number of mediocre ones) whose experience and training is worth a lot of money. That expertise would be lost if the company dissolved–it can’t be sold off, but it makes all those trademarks and software rights worth what they are, so it definitely adds to the value of those assets, so long as the company continues. Add in the value of that human capital, and the additional value of having the infrastructure, management, and strategic planning already worked out, and you probably get very close to the market cap, assuming the company is valued accurately.

What is the rest? Well if you didn’t include it in the tally above, there is the likelihood that MS will become even more successful at making software in the future. Even if it loses market share to Google and Linux, you can expect that the value of its assets will grow significantly in coming years. Most people are willing to pay more for a share of the company’s assets now, based on what they predict it be worth later.

So far, everything is perfectly rational. Remember, you could liquidate the company, but you don’t want to. The price you paid for it is based partly on the assumption that the company won’t liquidate, at least not anytime soon. It is possible that in 100 years, the company won’t be worth what it is, and it will be liquidated. It isn’t likely, but the shareholders could decide to liquidate when the assets are at their peak. Chances are, the peak won’t be obvious to everyone when it happens, and anyone who buys the stock after the peak will be “the greater fool,” but what they lose will be a tiny fraction of what was earned over the company’s history–unlike a pyramid scheme, where the last fools’ losses equal everyone else’s gains.

The rest of the market cap (if any) after everything I’ve mentioned is accounted for, is pure speculation about what other investors will do–turtles upon turtles. At any given point it is hard to know how much of the market value of a company this makes up. At some times for some companies, it might be quite a lot. But it isn’t the entire market by a long shot.

55

[QUOTE=Running with Scissors]
Suppose I buy 100 shares of MSFT for $30 each, or $3000 total. With a market cap of $290B, I think we can all agree that they’re not going to be a takeover target in the foreseeable future.

Three months goes by, a good earnings report comes out, and I sell my shares to A for $35 each, or $3500. I’ve made 500 (less commission, but let's ignore that). Microsoft's dividend is currently .40/yr (percentage wise, a very low rate of return, and obviously not a good reason [in and of itself] to own the stock), so add on another $10.00 profit. Another three months goes by and they have another good earnings report. A sells his shares to B for $4500 and makes $1000. B sells to C, C sells to D, and the cycle continues, ad infinitum. At some point in this chain, there has to be someone who wants the stock for the purpose other than to sell it to some other party. What is that purpose?
[/QUOTE]

Ownership. One share of stock gives you one vote on decisions that are made by shareholders. Own enough stock, and you make the decisions.

56

People are ignoring stock buybacks, which are a common way that companies provide cash to shareholders.

http://www.microsoft.com/presspass/press/2004/jul04/07-20boardPR.mspx

If the market cap is $300b and Microsoft buys back $30billion worth of stock, that’s equivalent to a very generous dividend.

What’s advantageous about stock buybacks is that the shareholders will generally be taxed at lower capital gains rates than the higher O/I (ordinary income) rates that would apply to dividends.

Also, as I said in an earlier post, if you own stock it is possible that the company will be aquired for cash. Tender offers take place all the time.

So, if you own stock in a successful company, eventually you are bound to receive cash through (a) dividends; (b) a stock buyback; or (c) a full on buyout.

57

[QUOTE=Running with Scissors]

Real estate - the property has definite utility - you can live in it, rent it out, or develop it and then sell the improved property for more money.

[/QUOTE]

I was just about to use this as an example. Let’s consider my house in the Bay Area, and an equally sized house in Iowa. Let’s say the lot is the same size, and the school system is of the same quality (though Iowa is probably better.) The utility is roughly the same. How come my house probably costs 3X the Iowa house? The valuation, in principle, is very similar to that of stock.

There is less risk with a house, which is why value fluctuates less, but the risk is non-zero.

I think there are very few things whose value can be set without the market.

58

[QUOTE=Voyager]
I was just about to use this as an example. Let’s consider my house in the Bay Area, and an equally sized house in Iowa. Let’s say the lot is the same size, and the school system is of the same quality (though Iowa is probably better.) The utility is roughly the same.
[/quote]

No it’s not.

The biggest reason is that a house in the Bay Area puts you within commuting distance of much higher paying jobs than in Iowa. Also, people put more value on the amenities of living in the Bay Area than those of living in Iowa.

The utility is very different.

59

[QUOTE=Voyager]
I was just about to use this as an example. Let’s consider my house in the Bay Area, and an equally sized house in Iowa. Let’s say the lot is the same size, and the school system is of the same quality (though Iowa is probably better.) The utility is roughly the same. How come my house probably costs 3X the Iowa house? The valuation, in principle, is very similar to that of stock.

There is less risk with a house, which is why value fluctuates less, but the risk is non-zero.

[/QUOTE]

Ridiculous. The utility of a house in the Bay Area is much higher! How do I know? Because the market value of an item is (partly) a function of its utility.

Keep in mind that utility doesn’t have to be practical. The utility of a painting is that is is pretty. The utility of a baseball card is that some people enjoy owning baseball cards. There doesn’t have to be any more to it than that. For some people, living in the Bay Area is enjoyable, and that enjoyment is the added utility of a house there compared to one in Iowa. It might not be a utility for you, but it is for enough people that the market value reflects it dramatically.

This is what a lot of people don’t get–EVERYTHING in the marketplace has utility for somebody. The only apparent exception is stock. Saying that stock is valuable because of the market doesn’t explain where the utility of stock comes from, because unlike value, the market doesn’t create utility, it reflects it.

60

[QUOTE=morgantire]
If a stock doesn’t pay dividends, then what connection does it have to the profits of the underlying company? Maybe that company’s profits are going up or down, but either way, your non-dividend-paying stock doesn’t let you get any share of that profits.

Take Google stock. It doesn’t pay dividends now, is unlikely to start paying dividends in the forseeable future, and has 2 classes of stock so that the founders can always out-vote the shareholders (so you can’t even buy all the stock and vote for the company to pay you the profits).
Even if you believe Google profits will go up and up for forever, the lack of dividends means the shareholders will never get to see any of those profits. So why does anyone buy the stock?
[/QUOTE]

The challenge of many of these threads is to keep rewording the reply until the OP and the OP’s supporters cave…this’ll be my last shot at it. :slight_smile:

Here is the nut of the OP, as I see it: “Even if you believe Google profits will go up and up for forever, the lack of dividends means the shareholders will never get to see any of those profits. So why does anyone buy the stock?” (underlining mine)

As discussed above, taking dividends is a way of taking a return now, instead of taking it when you sell the stock. This diminishes the current value of the company, but investors get some return that is then under their own control, to spend or reinvest. I think everyone’s good with that.

Stocks are bought, independent of whether they pay a dividend, in the hope that the stock price will rise. This rise in the price can be converted to a different investment vehicle upon sale of the stock. Such a transfer of vehicles is dependent upon the owner of the stock and the amount of proceeds is dependent upon the market price at liquidation.

The OP implies that the profit protection a dividend carries is such a good thing that it makes no sense to buy a stock which does not pay dividends.

This overweights the value of dividends. You would not invest 100k into a shady savings and loan that paid you a cash return of 10%/year but was likely to go belly up in 3 years. You might well invest 100k in a very solid CD with a 3 year term paying 10%/year even if you only get the return on the condition that you leave the investment undisturbed for 3 years. Investing in a non-dividend stock is a similar notion except that now you get to decide what you want the length of that return to be, and you are allowed to time your exit against the price of the stock.

It is not even true that you will “never get to see any of those profits” if you never cash out. This is because your net wealth increases as your holdings increase even if they remain invested in their original vehicles. If I buy company A stock at $100k and its value goes to $500k, my balance sheet shows a net worth increase of $400k. I can now borrow more economically, for instance, and I can leverage that wealth to create other wealth even if I never cash out my original stock. I can assure you that this is a big deal in the world of investment. In many ways money goes to money, and working capital to create more wealth goes to people with a good balance sheet even if they never see a penny in dividends from the stocks on their balance sheets.

So don’t let anyone talk you into or out of a stock just because it does not pay a dividend. And don’t let them pretend you are somehow dependent on a fool to bail you out of such an investment. In some sense the entire world is a house of cards, ultimately dependent on all of us agreeing on how we should interact politically and financially. The fool, on average, is the one who bunkers down waiting for the Big Comet to put an end to civilization. One day he will be right, but not on average.

OK. That’s it. I give up.

Full disclosure: I don’t own Google. I consider it ridiculously overvalued. I have been completely wrong so far. :wink: