# Theoretical value of non-dividend stock



## Pokkop (16 April 2014)

I think I have a fundamental problem of understanding the value of non-dividend stock,


Say, Company A is booming, and has these two parameters:

1.It doesn't pay dividend, ever
2. It's NOT going to get bought/acquired for the next 500 yrs, cuz it's so darn successful

What is motivating me to buy its stock? So when the stock appreciates I sell it to Bob. But the question is, why does Bob even want to buy it in the first place? Because by points 1&2 above, the comapany's never going to be converted to cash in Bob's lifetime. So Bob buys it so he can sell it to Steve. But the same question applies to Steve. Why does Steve want it if it's not going to convert to cash in his lifetime? And so on, so forth.

So, if theoretically this succesful company doesn't pay dividend and won't likely get acquired, what is the exact advantage of owning its stock. Since most small stock holders have no right to access the company profits/assets, how can they ever determine when their stock is converted to cash? And same goes for the next guy who bids for that stock. Are they all living on the same assumption that Company A may get bought during their lifetime and payup?

Thanks for helping


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## McLovin (16 April 2014)

This is a highly theoretical question for a public company because shareholders have voting powers and can vote in blocks. However, it is quite common in private companies for minority shareholders to be frozen out in this way. So for example, if I own 20% of XYZ Pty Ltd and the other owner owns 80% he may elect to not pay dividends or alternatively may be a very small dividend. In that instance the shares are valued not on the value of the underlying business but by pretty much assuming that today's dividend is how it will always be and treating it as a perpetuity with a very, very high RR. So, if the business is not paying a dividend, the minority shares may be all but worthless. 

One of the most common examples is say 3 people form a company each with 1/3 of the shares. Person A has a falling out with Persons B and C, so B and C vote to remove A as a director and manager (if he is one). They then continue running the company but begin paying themselves a higher salary and stop paying dividends. A's shares have become all but worthless, because who would want to buy them under such a scenario? The courts can fix this up because it is considered oppression of a minority shareholder.


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## ROE (17 April 2014)

Pokkop said:


> I think I have a fundamental problem of understanding the value of non-dividend stock,
> 
> 
> Say, Company A is booming, and has these two parameters:
> ...




I don't buy company if they make profit and don't intend to pay dividend, simple as that...so no need to value them 

I am happy for them to say we not going to pay dividend until X Y Z then I am happy
but for them not to pay dividend at all while making a profit has no benefit to me as a minority shareholder.

Don't care what other say, most argue that if they can generate high return they can keep
the cash and blah blah .... this is a nice but I am not going to risk leaving my share worthless
in the hand of management... Management has a history of wasting a lot of money...

I prefer profit is paid to me then I work out how to invest it, at least that way I have some control
of the capital...I can always buy more of the same company if I am happy with it but that should be
my decision...


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## Pokkop (17 April 2014)

ROE said:


> I don't buy company if they make profit and don't intend to pay dividend, simple as that...so no need to value them
> 
> I am happy for them to say we not going to pay dividend until X Y Z then I am happy
> but for them not to pay dividend at all while making a profit has no benefit to me as a minority shareholder.
> ...




Hi, I'd just like to ask, since I'm fairly new to stock- do most companies promise dividends after reaching a certain size? Is it a strict contract? How do I or any small shareholder ask for some return on our investment when a company becomes successful?


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## McLovin (17 April 2014)

Pokkop said:


> Hi, I'd just like to ask, since I'm fairly new to stock- do most companies promise dividends after reaching a certain size? Is it a strict contract? How do I or any small shareholder ask for some return on our investment when a company becomes successful?




No one promises anything. You can't have a contract because dividends can never be a guaranteed payment. Once a company gets to a certain size then it is in the interests of the company to start paying dividends because it lowers the company's cost of equity. Shareholders, while usually very, very apathetic, are unlikely to support a company hoarding cash for no specific purpose.


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## skc (17 April 2014)

Pokkop said:


> 1.It doesn't pay dividend, ever
> 2. It's NOT going to get bought/acquired for the next 500 yrs, cuz it's so darn successful




In your theoretical example, the theoretical value of such company is in fact zero. An analogy I liked is how much are you willing to pay for a chest of gold in the bottom of the ocean that you can never access. 

But both the theoretical value and the theoretical premises are just that, so in real life, even if a company is profitable and doesn't pay dividend for a long time, there are still plenty of buyers and sellers for the company's security.

Berkshire Hathaway is an example that fits some of your theoretical premises. That's only paid dividend once in the last 30-40 years. http://en.wikipedia.org/wiki/Berkshire_Hathaway


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## ROE (17 April 2014)

Pokkop said:


> Hi, I'd just like to ask, since I'm fairly new to stock- do most companies promise dividends after reaching a certain size? Is it a strict contract? How do I or any small shareholder ask for some return on our investment when a company becomes successful?




Most company do have a dividend policy lay out in their annual report and they update every so often as capital and their balance sheet changes.

Dividend is not guarantee it is a decision made at the board level and purely at their discretion.

Having said all that if a company has a dividend policy they will do their best to maintain it unless
they are no longer profitable or run into financial trouble .... your dividend is fairly safe from a business that has reliable revenue stream ...companies like WOW, WES, DMP, FLT, RFG, CCL ...

Aussie love their dividend and especially superfund managers..that how they get pay and ride the gravy train 

If you want reliable dividend stream stick to business with rock solid revenue stream.


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## ROE (17 April 2014)

skc said:


> Berkshire Hathaway is an example that fits some of your theoretical premises. That's only paid dividend once in the last 30-40 years. http://en.wikipedia.org/wiki/Berkshire_Hathaway




yeah this is one special case and because Warren Buffett at the helm even then he instructs all his managers to send him all excess cash ...that that goes to show he is not 100% confident leaving cash sitting with his own management.

excess cash tend to lead people to do stupid thing like over pay for asset or award themselves with excessive salary or throw crazy parties all at the expense of minority shareholders.

I seen too much too often so I prefer cash in my hand please 

Microsoft is a classic case, they been buying **** waste billion in the last 10 years...their shareholder would have done better if they lift their dividend instead going on buying junks


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## systematic (17 April 2014)

I'm struggling to remember the wording in the textbook (and it wasn't that long ago!)

A couple things:

PART ONE of answer:

a) Regarding the *theoretical* answer; dividends are irrelevant.  In a world with no taxes, transaction costs etc (wouldn't it be nice!) dividend policy doesn't effect the value of the company.  Think of it like this - if an investor wants cashflow, they can sell some shares.  If they want more risk you could borrow to invest (remember, no cost).

b) But we know that's not the real world.  Investors prefer a dividend to uncertain capital growth.  Therefore, in this explanation, 2 equivalent companies where one pays a dividend and the other doesn't; the dividend paying company will be valued higher.

c) Tax: Dividends are less prized when they are taxed at a greater rate than capital gains.


PART TWO of answer:

On the "how to value" part (I'm assuming your looking at the dividend discount model in this whole post), the idea is that the company would have a dividend (one big one) at the breakup of the company.  
Also, the shareholders own the company regardless of dividend.  So if the company pays a dividend to itself (by keeping all of the earnings) the share price will go up (we're talking theory, remember) - and therefore the company profits are passed onto the shareholders via the share price growth.  i.e. (remember our theoretical no cost world as above?) A shareholder can theoretically access that dividend by simply selling some shares. And that's why it's common in this model to replace the Dividends with Earnings in the case of no dividends.


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## DeepState (17 April 2014)

systematic said:


> I'm struggling to remember the wording in the textbook (and it wasn't that long ago!)
> 
> A couple things:
> 
> ...




Modigliani-Miller Theorem


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## ROE (17 April 2014)

back to the real world some people don't want to sell their shares but prefer dividend payment

buy selling shares you face capital gain tax, cost of sell and then you got to find a better business
than the one you just sold to park excess capital. Hassle free just to collect the dividend and imputation credit

good in theory, bad in practise


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## DeepState (17 April 2014)

ROE said:


> back to the real world some people don't want to sell their shares but prefer dividend payment
> 
> buy selling shares you face capital gain tax, cost of sell and then you got to find a better business
> than the one you just sold to park excess capital. Hassle free just to collect the dividend and imputation credit
> ...




Depending on your tax rate in the real world, you might get richer selling shares than getting a dividend - even if it is franked or to prefer stocks that don't pay a dividend or otherwise pay nominal dividends.  Or, better still, if you don't need the cash, buy stocks that don't pay a dividend and don't sell the shares until you do.  No hassles at all.  You don't even need to collect anything or redeploy.


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## ROE (17 April 2014)

DeepState said:


> Depending on your tax rate in the real world, you might get richer selling shares than getting a dividend - even if it is franked or to prefer stocks that don't pay a dividend or otherwise pay nominal dividends.  Or, better still, if you don't need the cash, buy stocks that don't pay a dividend and don't sell the shares until you do.  No hassles at all.  You don't even need to collect anything or redeploy.




My rules, business that make profit and doesn't pay me dividend I don't buy.
Just add another layer of risk... Risk I can control I don't give it away
My experience tell me

1. Dividend paying stock mostly out perform non dividend paying stock

2. Cash dont lie, you need cold hard cash to pay dividend..the ability of management manipulating profit is easy   without paying dividend.

3. When Management has too much cash, they tend to waste it on acquisition that add little value to the business they buy to generate higher revenue so they can pocket their bonuses.

4. Paying me dividend let me spot possible fraud or business in decline and exit 

No way I give these thing away by buying a non-dividend paying stock ...the risk is too great...


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## DeepState (17 April 2014)

RoE, what tax rate are you on?


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## ROE (17 April 2014)

DeepState said:


> RoE, what tax rate are you on?




I run investment but I don't own anything 
I have trust and most investment aren't under my name ...all go to lower tax bracket to take advantage of franking credits.


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## DeepState (17 April 2014)

ROE said:


> I run investment but I don't own anything
> I have trust and most investment aren't under my name ...all go to lower tax bracket to take advantage of franking credits.




Thanks.


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## luutzu (21 April 2014)

Dividend or no dividend does not affect the value of a company.

I think just about all large companies pay some dividends, it's probably more to make shareholders and institutional fund managers happy to pay their clients etc... It's part of business so it's understandable.

As an investor, you really want a good company that pays NO dividends.

You want the managers to keep the earnings, reinvest it for you and from the reinvestments, grow the company and thereby increase the share price and make you richer --- without paying taxes early (you delay paying taxes)... and capital gains tax is lower than income tax.

If a company pays you dividend, you have to pay it as income tax... then you will have to find ways to invest that dividends... So not only are you taxed, you'll need to spend time and effort to then reinvest what's left from the profits that's taxed.

Most company, not having enough earnings, still pay dividends to keep people happy and their share price up. You'd want to stay away from them... but it's hard and so there's that matter of judgment... some executives keep dividends and does nothing with it but waste it on some bad investments or themselves... you don't want to be in bed with those either so why want them to pay dividends to you instead?

What some companies do is have the Dividend Reinvestment Plan where they pay you a theoretical "profit" from the company, you pay the ATO tax on it, and instead of getting money, you get smaller pieces of what you already own, just further diluted.

I guess there's not many managers smart and brave enough like Warren Buffett.


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## springhill (21 April 2014)

The theoretical value of any stock is zero, dividend paying or not. As fiat currency (or any currency) is not anchored, currency itself is bought and traded and differing levels by the second.

It is humans that give value to everything - currency, service, metals, food, labor, luxury goods etc

The simple answer is the theoretical value of a stock/company is no greater than the value that a person in possession at any particular time decides to sell/trade/barter it with.

All 'profits' are made via speculation.

If you are the person unable to sell the stock for more than you purchased it for, then you are the one that others are relying on for theoretical valuation - as you have made the purchase at the highest value.

Of course, that all changes with the next trade, theoretical valuation is a moving feast and is differing all the time.

For example, if aliens were to take over tommorrow would current valuations on anything stay the same? They may decide that gold & oil are worthless and coffee rock and cordial are the new objects of value.

It is an extreme example but large fluctuations on anything of 'value' are affected by far less than that.

My  only.


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## Julia (21 April 2014)

luutzu said:


> As an investor, you really want a good company that pays NO dividends.



Aren't you failing to take into account individual circumstances of investors?   Some people are looking for an income stream (whilst always having as priority preservation of capital), having grown their capital sufficiently already.  A dividend of, say, 5.5% with 100% franking provides a decent yield, particularly in these times of low interest rates.



> You want the managers to keep the earnings, reinvest it for you and from the reinvestments, grow the company and thereby increase the share price and make you richer



Agree, if you're looking only for capital growth.  This, however, is not assured.  Plenty of companies which don't pay a dividend and still don't provide much in the way of growth.
There are opportunities for both likely capital growth and a history of good dividends.



> If a company pays you dividend, you have to pay it as income tax... then you will have to find ways to invest that dividends... So not only are you taxed, you'll need to spend time and effort to then reinvest what's left from the profits that's taxed.



Again, not everyone is paying tax and can enjoy the cash refund of the franking credit.  

Thanks for your thoughts.  It's always good to have some new opinions.


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## DeepState (21 April 2014)

springhill said:


> As fiat currency (or any currency) is not anchored, currency itself is bought and traded and differing levels by the second.
> 
> .




Utterly fascinating viewpoint and incredibly reasonable despite initially seeming alien - you must read heaps and have a massively open mind.  Please help me out.  If there is only a single country which does not trade of have capital movement with another....is it's currency anchored?  What if the money supply was fixed?  What if money consisted of Gold or other precious substance of fixed supply?  Or are you saying that because the price of Guns or Butter changes in the numeraire of the currency, that this makes it unanchored?  I'm probably way off and hence hoping for direction.

Fascinating.

Best.


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## DeepState (21 April 2014)

luutzu said:


> Dividend or no dividend does not affect the value of a company.
> 
> .



 Nice arguments.

The thesis behind your opening statement is the Modigliani Miller Theorem.  They developed it in 1958.  It contained the beautiful arguments you outlined.  However, it has ultimately been set aside.  Dividends do matter and affect stock prices empirically (I don't want to say...in the real world, as it might seem you are not there already).

Nonetheless, Modigliani got a Nobel in 1985.  Your's might be coming.


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## springhill (22 April 2014)

DeepState said:


> Utterly fascinating viewpoint and incredibly reasonable despite initially seeming alien - you must read heaps and have a massively open mind.




Either that or the cynic in me is growing ever stronger with each day that passes. 



DeepState said:


> Please help me out.  If there is only a single country which does not trade of have capital movement with another....is it's currency anchored?  What if the money supply was fixed?  What if money consisted of Gold or other precious substance of fixed supply?  Or are you saying that because the price of Guns or Butter changes in the numeraire of the currency, that this makes it unanchored?  I'm probably way off and hence hoping for direction.




Not possible, if a completely insular country has unavoidable population growth you automatically have more people chasing their own share of what they believe they need of a 'fixed' amount of currency to survive. Some believe that they need more than others.
To gain more currency citizens begin trading other objects of value. Theoretical value and speculation now enter the system, with the usual initial catalysts being the essentials of life - food & water, and then flowing on to lesser needs, wants and luxury items......

In essence, you have hit the nail on the head - changes in the value of needs & wants ultimately leads to the speculation and theoretical value flowing through to fiat currency or an alternative precious metal.

In essence countries have multiple currencies, they are just not officially recognised as such. 

For example drawing on my food production job, the values of a Chilean plum and an Australian plum in Singapore are vastly different.
As the Australian plum can be compared to a foreign plum and has earning potential or a tradeable value, does this not make it a form or currency open to theoretical value.....

I hope this made sense to you, in mind head it did. I just may not have converted it via keystroke in the best manner.


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## McLovin (22 April 2014)

DeepState said:


> Nice arguments.
> 
> The thesis behind your opening statement is the Modigliani Miller Theorem.  They developed it in 1958.  It contained the beautiful arguments you outlined.  However, it has ultimately been set aside.  Dividends do matter and affect stock prices empirically (I don't want to say...in the real world, as it might seem you are not there already).
> 
> Nonetheless, Modigliani got a Nobel in 1985.  Your's might be coming.




Yes, it's that pesky old Yogi Berra saying: In theory there's no difference between theory and practice; in practice there is.

MM does a great job of explaining how things _should_ work, not how they do work.


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## DeepState (28 April 2014)

McLovin said:


> Yes, it's that pesky old Yogi Berra saying: In theory there's no difference between theory and practice; in practice there is.
> 
> MM does a great job of explaining how things _should_ work, not how they do work.




Touche McLovin.  We should go for a ride in a cop car one day.


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## DeepState (28 April 2014)

springhill said:


> Either that or the cynic in me is growing ever stronger with each day that passes.
> 
> 
> 
> ...




I (think I) get where you are coming from.  Thanks for the response. Very much.

To pursue, if there is no single base currency because we are living in an Einstein-ian world of relative value, why is it that you conclude that things (ie. some stock that pays or doesn't pay dividends etc.) have no value?  If we agree that something can be traded for another, whether in the presence of speculation or not, can't we say that Berkshire Hathaway is trading at 200 Australian plums today and, given plums/food are necessary for life, that it has value?  That's the part that puzzles me most....that the argument asymptotes to zero value.  I don't get that part.  It seems like a sequi non to me, but I'm clearly missing something - what?

This is an utterly fascinating shift of reference frame which you have tabled - thank you.  Is this whole economy a charade which greases its mechanism via trade in sheets of paper and electronic versions of it?  I'm not going to argue the against case too strongly.

Best


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