What are stocks actually worth if they never pay dividends?
September 15, 2007 9:29 PM   Subscribe

What intrinsic value does any stock have if it never pays any dividends and has no plans to ever do so?

I feel dumb for asking this question, but I've been thinking about it all day and only getting more and more confused. The debate in this thread only makes me more unsure - what MattD says makes perfect sense to me, but since he's just rephrasing Tirade, and everyone said Tirade was wrong, I become unsure.

Stocks that pay dividends, or will eventually pay dividends, make perfect sense to me. I pay some money to gain partial ownership of this company, which will in turn share its profits with me in the form of dividends. If the company is doing well, other people will want to buy in, and as a result, the share price will increase. Now I can sell my shares for a profit.

If the company isn't paying dividends now, but chooses to reinvest its money, this is fine; it only means that the dividends in the future will be even larger. I might not stick around with the company long enough to receive any of those dividends. But because of the company's growth, people realize that the eventual dividends will be even larger, and demand for the stock goes up, resulting in a higher share price. Now I can sell my stock to somebody else, who will eventually sell it to somebody else, and so on, and so forth, until somebody gets the dividends. It might be 25, 50, or 100 years from now, but as long as somebody eventually gets dividends, it makes sense to me, because the shares have an intrinsic value: present or future profit from the company itself.

Now, suppose we take dividends out entirely. This is how I see it. Suppose companies are actually sealed boxes with cash inside of them. These boxes have the magic power of generating money at varying rates. The boxes are indestructible, so there is no way of breaking them open and getting the money. The magic boxes, just like companies, have their IPO and people can put money into the box to buy shares of stock, which represent partial ownership of everything in the box. The only catch is that you can't actually use the cash that you own, since it's sealed inside the box.

Every year, Box A spits out (just for you) a portion of the money it generated that year, based on how much of the box you own. Since the boxes are always guaranteed to generate money, other people are interested in buying shares, and as a result of high demand, you can sell your shares to them for a profit.

Box B generates money faster than box A, but it won't spit out any money for the next ten years. This is OK, because by the time it spits out money, it'll spit out way more money than box A will. So there's still demand for the stock, and shares appreciate in value.

Box C generates money even faster than box B, but it will never, ever spit out any money to anyone for the rest of eternity. Again, you have no way of breaking open this box and getting the cash that you supposedly own. The cash is legally yours, but you can't use it. Your only hope of making any usable money is selling off your shares to somebody else. The amount of cash each share represents goes up a tremendous amount every day, but again, there is no way of actually getting that cash.

Now, why on earth would anyone put money into box C in the first place, and why would anyone in their right mind want to buy shares of box C?! Do shares of box C have any intrinsic value beyond the paper they're printed on?! If there's never any chance of getting any REAL money from box C, then are the shares really worth anything? Correct me if I'm wrong, but isn't box C behaving the same way as a company which will never issue any dividends? When companies like Google state that they have no plan to issue dividends in the forseeable future, what is a share in that company actually worth in itself, other than money you can't actually get? What does your ownership of Google represent beside a paltry few votes for the board of directors? Why are people willing to trade with each other for a piece of the pie that nobody will actually get? What happens when Google gets so big that they just can't grow anymore, no matter how much they reinvest?

Thanks, guys. Go easy on me if there's just some really obvious misunderstanding.
posted by pravit to Work & Money (16 answers total) 5 users marked this as a favorite
 
People will put money in Box C because, unlike Box A and Box B, it is singularly focused on making the box *bigger*.
posted by deCadmus at 9:46 PM on September 15, 2007


deCadmus: I think is question is why people care about the size of the box if it never spits anything out.
posted by null terminated at 9:50 PM on September 15, 2007


What happens when Google gets so big that they just can't grow anymore, no matter how much they reinvest?

That's when Google will start issuing dividends. "Never" is not even close to the same as "the forseeable future".

On a more abstract level, a share in box C is still worth something because if the shareholders really felt that the company was wasting money by keeping it in the box rather than giving it out, they'd vote in new directors that would give out dividends. What the directors today say will happen has only a slight connection to reality as long as the shareholders are willing to enforce their own interests through voting - it's not that Box C is incapable of issuing dividends, it's that someone says it won't for the next 3-5 years.
posted by 0xFCAF at 9:51 PM on September 15, 2007


The ultimate value of the stock is in someone else's willingness to buy it. A company that pays no dividends instead reinvests that money in making the company larger, and eventually it will become a target for acquisition. At that time, if you're holding stock in it, the price will go way up.

The other value of stock is voting rights as a shareholder. Sometimes some big player will buy a large minority share in a company in order to be able to influence the direction the company will take, and that will make prices go up, permitting you to cash out.

...or permitting whomever you earlier sold your shares to. Or whomever they sold them to. Everyone is willing to hold the shares because there's an expectation that eventually someone will want them for reasons other than simple speculation. This isn't a "greater fool" situation; the eventual large-scale buyer of stock has other purposes in mind than simple speculation.
posted by Steven C. Den Beste at 9:52 PM on September 15, 2007


Stock in a company is worthless unless there exists some mechanism for shareholders to share in the company's profits- either through dividends or the company repurchasing shares.

But just because a company has no immediate plans to pay dividends doesn't mean they're unable to.

Companies pay dividends when there isn't anything better they could be doing with the money. If Google says they have no plans to pay dividends in the near future, it means they feel the money will make better returns for their shareholders if they invest it back in the company-- hiring more developers, advertising, etc.

To use your magic box scenario, imagine you and nine friends had a box that you could store money in that increased the amount of money in it by 20% a year. Every month you voted on whether or not to take money out. Although no one could take money out without a majority agreeing, you could sell your stake in the box to anyone who was interested. Of course no one ever votes to take money out, because 20% a year is fantastic-- so this box becomes just like your Box C. A box that always increases the amount of money in it, but no one ever takes any out.
posted by justkevin at 9:53 PM on September 15, 2007 [1 favorite]


The assumption is that over time Google will make the extra money grow faster than if they gave to you in dividends, you pay taxes and invest the rest in T-bills.

If Google got to the point where they couldn't make a decent return from investing their money in the company or in acquisitions, then it will get pressure from the shareholders to start paying dividends with its extra cash.

With some companies there is also the possiblity of being acquired or liquidated or parts of the company spun-off that might produce either cash or shareholders or shares in another (possibly dividend paying company)
posted by metahawk at 9:57 PM on September 15, 2007


Quick answers! Thanks, guys - these answers confirm what I was thinking all along - that at some point of time, even if it is a thousand years from now, somebody has to actually get something, where it be from dividends, an acquisition, or the company buying shares back.

So, just to clarify, if box C was totally sealed, you couldn't vote on its behavior, it never bought shares back, and nobody else would ever acquire it, then its shares would be worthless, right?
posted by pravit at 10:00 PM on September 15, 2007


Worthless in the sense that nobody *should* buy it, yes.
posted by Flunkie at 10:02 PM on September 15, 2007


Companies with lots of cash on hand also like to buy up the some of the outstanding shares of the stock. This tends to drive the stock price up (since it's the same company split into fewer parts). So it ends up acting like a dividend in some ways, without being a dividend.
posted by smackfu at 10:04 PM on September 15, 2007


It all makes sense now! That was fast! Thanks, MeFi!
posted by pravit at 10:12 PM on September 15, 2007


A company that pays no dividends instead reinvests that money in making the company larger, and eventually it will become a target for acquisition. At that time, if you're holding stock in it, the price will go way up.

The other value of stock is voting rights as a shareholder. Sometimes some big player will buy a large minority share in a company in order to be able to influence the direction the company will take, and that will make prices go up, permitting you to cash out.



Steven's got it. Somebody is gonna want those profits. When they do, they will pay for them. You will profit.
posted by Ironmouth at 10:45 PM on September 15, 2007


Stocks that pay dividends, or will eventually pay dividends, make perfect sense to me. I pay some money to gain partial ownership of this company, which will in turn share its profits with me in the form of dividends. If the company is doing well, other people will want to buy in, and as a result, the share price will increase. Now I can sell my shares for a profit.

Congratulations, sir. You have seen to the bullshit at the core of the current market. A stock that will never pay dividends is worth only the sale or liquidation value of the company. This can still be a lot of money, but that's the measure of a stock's worth when it doesn't pay you anything to hold it.

The reason, in theory, that investors are willing to buy stocks that pay no dividends is because the company can use that money to grow; it's the old thing of money now or money later. Even Warren Buffett's stock, Berkshire, is not worth near face value, unless he changes his policy of never paying dividends. His companies are capable, of course, of spinning out huge amounts of cash, but don't, because Warren can use the money to buy and groom more businesses; he's a better investor than almost anyone.

But even Buffett has said that it's really hard for him to grow much anymore. I believe they should probably be converting to dividends, rather than just accumulating capital that's not being fully used. Presumably, eventually that stock will indeed pay a dividend, and will become worth its fantastic price, but if it never does, it's worth far less -- just the sale value of the companies involved.

Owning a company, in and of itself, means nothing; only the money you can extract from that company has value. If they never pay dividends and don't get sold to some larger entity, there's no difference between owning 90% of a dry cleaner or 90% of Google.

Most current stocks are worth nowhere near their price levels, because of the stupidity in the casino, er, stock market. People buy $1 bills for $3, hoping to sell them for $5 later on. People buy them for $5, and then sell them for $7... and then yet more people see the trend and buy in and take it to $20 or $50 or whatever. Eventually, you reach the Greatest Fool, and he can't find anyone to sell to. Things get bad after that.

Again, congrats on seeing this. Most people don't.
posted by Malor at 12:51 AM on September 16, 2007


Companies with lots of cash on hand also like to buy up the some of the outstanding shares of the stock. This tends to drive the stock price up (since it's the same company split into fewer parts). So it ends up acting like a dividend in some ways, without being a dividend.

Ah, yes, this is a sneaky way of paying dividends. I should have mentioned that.
posted by Malor at 12:52 AM on September 16, 2007


The boxes are indestructible, so there is no way of breaking them open and getting the money

But there is. There always is. That's why we have raiders, err, "activist investors."

What happens when Google gets so big that they just can't grow anymore, no matter how much they reinvest?


And this question is a bit misguided. The question is not whether Google can grow any more, but whether Google can earn economic profits on new investment. If Google can no longer generate economic profits on new investment, that's when it should return cash to shareholders. Firms typically do this by paying dividends or buying back shares.

pravit, if this is more than an idle curiosity for you, I strongly suggest reading Bennett Stewarts The Quest for Value (probably free from your library). It answers most or all questions of the nature that you pose.

Companies with lots of cash on hand also like to buy up the some of the outstanding shares of the stock. This tends to drive the stock price up (since it's the same company split into fewer parts). So it ends up acting like a dividend in some ways, without being a dividend.


Heh. This is approximately true, but it's not that simple. First and foremost, stock buybacks are generally the most tax-efficient way to return cash to shareholders. They are also a limited signal that the stock is undervalued, and a limited signal that the company is comfortable with its ability to generate cash. In some cases buybacks are EPS accretive, but unless the shares are undervalued (due to information asymmetry), buybacks do not create value aside from tax minimization.

And Malor, you're one of my favorite posters, but I'm convinced that you're really wrong on this one. If you know anyone who works in the investment business, see if you can play around with his/her HOLT application; it is fully transparent, and I suspect that it will challenge some of your intuitions.
posted by Kwantsar at 10:46 AM on September 16, 2007


You can learn more about buybacks by reading Marty Leibowitz's Franchise Value, or by reading some of Michael Mauboussin's CSFB pieces.
posted by Kwantsar at 10:50 AM on September 16, 2007


What happens when Google gets so big that they just can't grow anymore

Well, when Google owns all property and governments, and has implanted mandatory search and control technology into all of our brains to connect us to the Great Mainframe, their stock will have become basically a side issue.
posted by nanojath at 4:18 PM on September 16, 2007


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