If a company is not growing anymore, the only reason to own shares is to get dividends. If the P/E ratio is too high, then the amount of annual dividends per dollar of share won't be worth the risk of the company going bust.
Stocks make investors (contrasted with traders) money either by (a) going up in price or (b) paying a dividend every quarter. In order to make your stock price go up, you have to show not just profits, but growing profits. With something like Wal-Mart, this just means either cutting costs or selling more stuff to more customers. However, Facebook is going to (over the next few years) approach market saturation - they hit 500 million users 6 months ago, and there are only two billion internet users world-wide, meaning they can't keep growing at their historical pace forever. As that user growth slows, there are two ways to increase revenues (and profits) - either extract more money from each user or diversify into other products or services. If they can't do that, then they have to reorient into a "own our stock because we pay dividends" slow-growth company like Microsoft.
A company can also buy its own stock. In the short term this has little impact on the stock price, but as future profits are shared among a smaller pool of investors you can cycle though rising price and splits even with a stable income stream.
PS: This is only really efficient when the P:E hovers around 10:1 but it has great tax implications for long term investors.
Most tech companies do stock buybacks rather than dividends. From the point of view of shareholders, it is almost the same thing.
Here are the differences. Dividends generate ordinary income, which people may have to pay taxes on. Dividends drop the price of the stock by the amount of the dividend.
By contrast a stock buyback reduces the value of the company and the outstanding stock by the same amount, and therefore leaves the stock price alone to first order effects. Over time this increases the likelihood of incurring long-term capital gains, which are generally better from a taxation purpose.
The never stated difference, which I think is important, is that dividends hurt anyone holding options, while a stock buyback increases volatility which helps anyone holding options. Since tech companies tend to have lots of employees with options, this matters a lot to them.
Very few, and why does anybody buy their stock? This guy I know has been borrowing more and more money for years and never paid a red cent back, and now you want to lend him your money?
A company does not need to pay dividends in order to be worth to have a share in it. As long as the assets of the company are stable or growing, owning a piece of it is like having a secure bond. Dividends are either profit sharing when the company can't do anything productive with their extra cash... or attempts by management to keep their valuation afloat in order to collect bonuses.
I'd say that if a company has extra cash, it is better off paying its long term debts rather than dishing it out to the shareholders. Stock valuations rise and fall, but the underlying stability of the company should be worth more.
A share of a company is in theory optimally priced when it has the same value as the net present value of all future income streams that come from it: that includes both its dividends, and any profits from reselling it. Assuming we're talking about a company that is no longer growing (that's the presumption in the post you are replying to), then owning a share of it has negative value unless its dividends (or moral equivalents, like share buybacks) exceed at least the rate of interest - you can earn more risk-free by putting your money elsewhere.
> I'd say that if a company has extra cash, it is better off paying its long term debts rather than dishing it out to the shareholders.
That kind of blanket statement makes absolutely zero sense to me, and surely if you thought about it for more than 5 seconds, you too can see how silly it is. If the company's return on borrowed money is higher than the interest rate it pays on that borrowed money, paying down the loan would be a waste of money.
Consider a large shop that has a mortgage on its premises. Is it best for it to invest all its profits in paying down its mortgage? Or should it open up a new branch elsewhere instead, borrowing the money for the premises, on the basis that its business model has been proven to have profit that exceeds the cost of finance? Which would make more money? Now consider another scenario: rather than the shop opening up a new branch, what if the investors (i.e. the owners) want to invest in a different or new business, with potential for higher returns in the future?
Yes, if a company has stopped growing, then its valuation will go down in time (primarily due to inflation), but then giving dividends just hastens the decline. If a company's value is going down, it makes only short-term sense to give out money. It may just mean some unprofitable assets have to be sold off, or the company needs deeper restructuring.
If the company is profitable and its value is growing against inflation (slow growth), then it's worth having a share in it even if it's not paying dividends. (It's actually hard to find something solid that grows against inflation, in the long term).
>If the company's return on borrowed money is higher than the interest rate it pays on that borrowed money, paying down the loan would be a waste of money.
The company's 'returns' on paying dividends is actually negative, all other things equal.
>Now consider another scenario: rather than the shop opening up a new branch, what if the investors (i.e. the owners) want to invest in a different or new business, with potential for higher returns in the future?
If the investors really think they're not getting their money's worth (i.e. the separate assets are worth more or the management is bad), then it makes sense to initiate a takeover.
P.S. please downvote after you have heard a reply.
