nevermind
Argh! I am the OP and that’s not remotely what I was saying! You still don’t understand the question.
Suppose a company has a policy to always reinvest 100% profits back in the company. Now what? Yes, the value of the company (and your share) is increasing since 100% profits are being reinvested, but if you held the stock until the company eventually folds, you’d get no profits along the way and be left with only the break-up value of the company. Lawyer fees and desperation strategies to avoid bankruptcy will eat up most of that break-up value (plus a lot of the value is in “brand name equity” that often can’t be easily sold), so if you hold on to the stock forever, you’ll get back less than you paid. Therefore, you wait for the stock to rise a bit, and then you sell.
But the guy who buys it from you is in the same position – if he’s holding the stock when the company folds, he’ll get nothing. So he’ll only buy your stock if he thinks he can sell it to someone else. Who also has to sell it to someone else. And so on.
Nobody would buy the stock if they thought they’d be the last owner. But given that the only way to make money is to sell, then who would buy if they thought they’d be the next-to-last owner? Or the next-to-next-to-last owner?
That’s my question. I’m looking for the theoretical explanation of why the above example is not just a pyramid scheme. Yes, clearly in the real world, you can profit by buying stocks without dividends. Agreed. But I want the economic explanation for why it works.
You’ve been given virtually an entire course in economics. What is there that can possibly be left to tell you? If you still don’t get it, then reread the thread. It’s been explained to you in half a dozen ways why your thinking is wrong and another half a dozen times what the theoretical and real world explanations are for why the market acts as it does. We can’t make you see the world correctly, but the information is there any time you want to grasp it.
Let’s suppose that the company’s policy is to reinvest 100% of its profits. No dividends and no stock buybacks. Just 100% reinvestment.
Eventually, the company will be “mature,” meaning that it can’t grow much more, meaning that it’s grown about all it can grow. Cash is pouring in – much more than is necessary to maintain the business. What happens next? There are a few possibilities.
First, the company could start paying dividends or institute a stock buyback program. These are the most common things that are done. Obviously if you own shares, you are getting a cash return on your investment. But we assumed that the company does not do these things.
Second, the company could start saving money in the bank. Some companies have large cash reserves. If the company starts doing this, eventually somebody will notice that the company has a ton of cash and a ton of cash flow and make a hostile tender offer for the company. i.e. make a cash bid to acquire a controlling interest in the company and all that cash. In this scenario, if the price of a stock drops low enough, there is sure to be some sort of takeover bid. So the possibility of a takeover bid will keep the price above a certain level, even without dividends or stock buybacks.
Third, the company could start acquiring other companies, i.e. investing in the stock market. But for the same reason as Case 2, this will eventually invite a takeover bid.
Last, the company could start investing its profits foolishly. But again, this will invite a takeover bid.
Ultimately, even if a successful company pays no dividends and has no stock buyback program, its stock has value. Because if the stock drops too low, somebody will take over the company and seize control of that cash flow.
Look, in theory the price of a stock ought to be the net present value of cash flow (discounted cash flow) minus a suitable risk premium.
That cash flow is never going to go anywhere except to the shareholders. There is nowhere else that it can go. It can only be invested, distributed to investors in the forms of dividends, or spent on (ideally profitable) business activities. All of these options eventually add to the value of the company - and a shareholding reflects the holder’s share in said company.
I don’t really see why there is any difficulty here.
I think the question on the OP’s mind is what the mechanism is for getting that cash flow to shareholders.
As I said in earlier posts, the main mechanisms are (1) dividends; (2) a stock buyback; (3) a takeover or buyout.
If the company is successful, the possibility of those 3 things happening will keep the share prices from going too low.