What is with Businesses that don't pay dividends (besides the obvious)?

[pythagoras]

Hi folks,

Before i begin, please don't mistake me for being cynical, rather see me as exploring while i learn more about this world of business.

The past couple of weeks I have been attempting to find the ins-and-outs of why a business is structured not to pay dividends, but rather lucrative employee benefits.



It makes perfect sense to re-invest into the business and in so doing hold off from paying dividends. (this could be for 3-5-10 years). And i would be happy as an investor with this business model.

However, one could be critical to see 'employee' benefit schemes as a veil to enrich the top of the pyramid (quite genius really).
While directors and other execs are using their own chartered super-funds for 40% pre tax benefits with stock options and various other benefits trailing for years.

The other thing i noticed is when a business is going to lender market for a loan, it tends to pay returns on the loan to the bank, rather than trying to raise funds solely through investor programs.

So once again, the banks get there cut within a relatively short period, but the millions raised by 'retail' investors get nothing, except for one day selling their holdings at a higher price than what they purchased them at, which doesn't match the ROI the bank made (considering current cash rate, and banks creative way of using credit).



Does any one know of any businesses that at one time didn't pay dividends (purpose to grow) then selected to start paying dividends?
Or is it standard practice to continue business not paying dividends (like what old man Trillionaire Buffet does with his business )


Kind regards,

Py

 

[So_Cynical]

Does any one know of any businesses that at one time didn't pay dividends (purpose to grow) then selected to start paying dividends?
Or is it standard practice to continue business not paying dividends (like what old man Trillionaire Buffet does with his business )

I bought OVH expecting to get dividends after a couple of years, i did get one after waiting maybe 2 years and then still lost capital in the takeover, its actually a reasonably rare event, buying a stock that has never paid a dividend and then getting regular divs once profitable.

 

[Value Collector]

Hi folks,

Before i begin, please don't mistake me for being cynical, rather see me as exploring while i learn more about this world of business.

The past couple of weeks I have been attempting to find the ins-and-outs of why a business is structured not to pay dividends, but rather lucrative employee benefits.



It makes perfect sense to re-invest into the business and in so doing hold off from paying dividends. (this could be for 3-5-10 years). And i would be happy as an investor with this business model.

However, one could be critical to see 'employee' benefit schemes as a veil to enrich the top of the pyramid (quite genius really).
While directors and other execs are using their own chartered super-funds for 40% pre tax benefits with stock options and various other benefits trailing for years.

The other thing i noticed is when a business is going to lender market for a loan, it tends to pay returns on the loan to the bank, rather than trying to raise funds solely through investor programs.

So once again, the banks get there cut within a relatively short period, but the millions raised by 'retail' investors get nothing, except for one day selling their holdings at a higher price than what they purchased them at, which doesn't match the ROI the bank made (considering current cash rate, and banks creative way of using credit).



Does any one know of any businesses that at one time didn't pay dividends (purpose to grow) then selected to start paying dividends?
Or is it standard practice to continue business not paying dividends (like what old man Trillionaire Buffet does with his business )


Kind regards,

Py

Hi Pythagoras,

Basically you have asked two important questions, and the answers are based on the two of the most foundational things an investor in company equity needs to understand.

Your first question is basically "why would it make sense not to pay a dividend long term"

The answer to that is based on simply math, lets say a company has a growing business where it can invest fresh capital and earn 25% return, so if it retains $1 of earnings per share it will grow earnings per share by $0.25. Now if that company trades on a PE ratio (price to earnings ratio) of 10, increasing earnings by $0.25 will increase the share price by $2.50 So in that situation it makes total sense for the company to retain 100% of earnings because every $1 of avoided dividends increases the share price by $2.50.

An extreme example of this is Berkshire Hathaway, they cancelled their dividend over 50 years ago, and the share price was $6 at the time, today the share price is $347,815 per share (yes over $340K per share), this huge growth has only been possible because they don't pay dividends and have been very good at reinvesting those retained earnings.

-----------------------------

Your second question is why a company would borrow rather than raise more equity from shareholders.

The answer to that comes back to a similar idea to what I discussed above, lets use that same company I described above that is earning 25% return on the money it invests in itself eg, 25% return on equity.

lets say it has $10 of equity per share, and it earns 25% on that equity.
its earnings per share will be $2.50 and its share price will be about $25 based on a pe of 10.

Now lets say it can go to the bank and borrow money at say 4% interest, and then invest those funds at 25% by expanding its business, Yes it is paying returns to the bank, but the existing share holders benefit greatly because it only pays the bank 4%, and the other 21% generated accrues to the benefit of the shareholders.

So these bank loans will change the the picture quite a bit,

So instead of the company looking like this -
$10 of equity per share, that earns 25% on that equity = $2.50 earnings per share, and its share price will be about $25 based on a pe of 10.

The company might look like this -
$10 of equity per share, that earns 25% on that equity = $2.50 earnings
+
$5 of borrowed money per share, that earns 21% (after interest) = $1.05 earnings
=
$3.55 of earnings with a PE of 10 means a share price of $35.50.

So by borrowing money from the bank the company was able to grow and increased the share price from $25 to $35.50 without the share holders having to put in any extra cash to fund the growth.

A company might choose to fund growth using debt as a way to grow the company, and increase earnings per share without having to cut the dividend, so shareholders can get both capital gain and dividends if all works out well, or some companies even borrow money so they can return equity to share holders, eg pay out larger dividends or rebuy shares as they replace shareholders funds on they balance sheet with borrowings.

Disney did this for a number of years, they took on debt to fund about $10 Billion of stock buybacks a year, for each $10 Billion of shares they repurchased they used about $5 Billion from earnings and $5 Billion of debt, because interest rates were so low and their stock was cheap it made sense.

 

[Value Collector]

Does any one know of any businesses that at one time didn't pay dividends (purpose to grow) then selected to start paying dividends?
Or is it standard practice to continue business not paying dividends (like what old man Trillionaire Buffet does with his business )

Apple didn't pay a dividend for 17 years, but began paying in 2012.
Walt Disney company didn't pay dividends for the first 34 years.
Microsoft didn't pay dividends for the first 28 years

there would be heaps of examples, basically as long as the company is growing and able to sensibly deploy capital at high rates you want they to retain cash, once they mature and start building up cash faster they they can deploy it rationally you want them to pay dividends or buy back stock.

 

[pythagoras]

Hi Pythagoras,

Basically you have asked two important questions, and the answers are based on the two of the most foundational things an investor in company equity needs to understand.

Your first question is basically "why would it make sense not to pay a dividend long term"

The answer to that is based on simply math, lets say a company has a growing business where it can invest fresh capital and earn 25% return, so if it retains $1 of earnings per share it will grow earnings per share by $0.25. Now if that company trades on a PE ratio (price to earnings ratio) of 10, increasing earnings by $0.25 will increase the share price by $2.50 So in that situation it makes total sense for the company to retain 100% of earnings because every $1 of avoided dividends increases the share price by $2.50.

An extreme example of this is Berkshire Hathaway, they cancelled their dividend over 50 years ago, and the share price was $6 at the time, today the share price is $347,815 per share (yes over $340K per share), this huge growth has only been possible because they don't pay dividends and have been very good at reinvesting those retained earnings.

-----------------------------

Your second question is why a company would borrow rather than raise more equity from shareholders.

The answer to that comes back to a similar idea to what I discussed above, lets use that same company I described above that is earning 25% return on the money it invests in itself eg, 25% return on equity.

lets say it has $10 of equity per share, and it earns 25% on that equity.
its earnings per share will be $2.50 and its share price will be about $25 based on a pe of 10.

Now lets say it can go to the bank and borrow money at say 4% interest, and then invest those funds at 25% by expanding its business, Yes it is paying returns to the bank, but the existing share holders benefit greatly because it only pays the bank 4%, and the other 21% generated accrues to the benefit of the shareholders.

So these bank loans will change the the picture quite a bit,

So instead of the company looking like this -
$10 of equity per share, that earns 25% on that equity = $2.50 earnings per share, and its share price will be about $25 based on a pe of 10.

The company might look like this -
$10 of equity per share, that earns 25% on that equity = $2.50 earnings
+
$5 of borrowed money per share, that earns 21% (after interest) = $1.05 earnings
=
$3.55 of earnings with a PE of 10 means a share price of $35.50.

So by borrowing money from the bank the company was able to grow and increased the share price from $25 to $35.50 without the share holders having to put in any extra cash to fund the growth.

A company might choose to fund growth using debt as a way to grow the company, and increase earnings per share without having to cut the dividend, so shareholders can get both capital gain and dividends if all works out well, or some companies even borrow money so they can return equity to share holders, eg pay out larger dividends or rebuy shares as they replace shareholders funds on they balance sheet with borrowings.

Disney did this for a number of years, they took on debt to fund about $10 Billion of stock buybacks a year, for each $10 Billion of shares they repurchased they used about $5 Billion from earnings and $5 Billion of debt, because interest rates were so low and their stock was cheap it made sense.

Hi VC,

Thank you for your indepth answer to my inquiry, I appreciate it.
It has given me another perspective and understanding in-which to value a businesses method(s) to build and grow.

Kind regards,
Py

 

[Dona Ferentes]

It has given me another perspective and understanding in-which to value a businesses method(s) to build and grow.

Here is another view, a quote, that makes a lot of sense

--------------------

"Every long-term security is nothing more than a claim on some expected future stream of cash that will be delivered into the hands of investors over time."
- Dr John Hussman

He goes on to say something important about expectations (of course this assumes the investor is buying for the long term):
"For a given stream of expected future cash payments, the higher the price investors pay today for that stream of cash, the lower the long-term return they will achieve on their investment over time."

 

[pythagoras]

Here is another view, a quote, that makes a lot of sense

--------------------

"Every long-term security is nothing more than a claim on some expected future stream of cash that will be delivered into the hands of investors over time."
- Dr John Hussman

He goes on to say something important about expectations (of course this assumes the investor is buying for the long term):
"For a given stream of expected future cash payments, the higher the price investors pay today for that stream of cash, the lower the long-term return they will achieve on their investment over time."

Thanks Dona,

I'm definitely in it for the long haul,however, I still have a concern with 'employee benefits schemes' which seems like enrichment not truly earned. Although it be seen as 'common practice' it doesn't make it right.
The bar seems quite low for KMP (key management positions) to get crazy share benefits metered out into their superfunds.
I'd rather see that 200k+ allocated elsewhere.


I for one, when given the chance, will select to limit these enrichment schemes for the business I have invested in.

Kind regards,
Py

 

[Value Collector]

I still have a concern with 'employee benefits schemes' which seems like enrichment not truly earned. Although it be seen as 'common practice' it doesn't make it right.
The bar seems quite low for KMP (key management positions) to get crazy share benefits metered out into their superfunds.
I'd rather see that 200k+ allocated elsewhere.

Having good or bad management can either make or break a business, paying a decent amount to attract and retain good management can be a very sound investment, Some of the best managers in the world are already independently wealthy, so you are unlikely to be able to retain them and keep them enthusiastic about working long hours and nights without compensating them well, especially if other companies both public and private are head hunting them, I mean if the pay isn't good enough they might prefer to run you competitors business or maybe just be on the golf course, while another monkey runs your business and loses you more money than it would have cost to pay the good manager.

Think about it like this, Fortescue Metals has been one of the best run mining companies in Australia for a number of years now, and the dividends to share holders this year is likely to be more than $ 6,000,000,000 ( $6 Billion ) + a few Billion of retained earnings, Now if we as shareholders are being paid $6,000 Million it would be a bit rich to be stingy to try and cut management pay and not share few Million with the top management.

 

[Value Collector]

Having good or bad management can either make or break a business, paying a decent amount to attract and retain good management can be a very sound investment, Some of the best managers in the world are already independently wealthy, so you are unlikely to be able to retain them and keep them enthusiastic about working long hours and nights without compensating them well, especially if other companies both public and private are head hunting them, I mean if the pay isn't good enough they might prefer to run you competitors business or maybe just be on the golf course, while another monkey runs your business and loses you more money than it would have cost to pay the good manager.

Think about it like this, Fortescue Metals has been one of the best run mining companies in Australia for a number of years now, and the dividends to share holders this year is likely to be more than $ 6,000,000,000 ( $6 Billion ) + a few Billion of retained earnings, Now if we as shareholders are being paid $6,000 Million it would be a bit rich to be stingy to try and cut management pay and not share few Million with the top management.

This basically comes back to the age old problem, labour vs capital vs The Tax man.

Eg. how much of and enterprises output should be used to compensate the people providing the labour (employees including management) vs how much should go towards compensating the capital owners (shareholders and debt holders) vs how much should be directed to the governments coffers (the tax man).

Obviously the business can not produce profits without the labour of the workers and management, and obviously those workers wouldn't be able to produce anything without the capital investment that comes from shareholders and debt holders, So both groups deserve a piece of the pie based on their input and risks they take to keep the business going, and the rest of society deserves their cut from the tax man too.

 

[pythagoras]

Hi folks, you make good points, and I agree with you, if, however, the criterion is rightly met.

I believe we tend to forget that
"correlation does not prove causality", and therefore even a though a business is doing very well it does not necessarily mean due to the whole efforts of let's say the 'directors' of that business.

These enrichment schemes seem to be rather, but not always, supported by an unexamined culture that belies assignment of value.

Kind regards,
Py

 

[Value Collector]

Hi folks, you make good points, and I agree with you, if, however, the criterion is rightly met.

I believe we tend to forget that
"correlation does not prove causality", and therefore even a though a business is doing very well it does not necessarily mean due to the whole efforts of let's say the 'directors' of that business.

These enrichment schemes seem to be rather, but not always, supported by an unexamined culture that belies assignment of value.

Kind regards,
Py

At the end of the day the directors hire the management, and the shareholders vote in the directors, So shareholders can change up the management and directors if they decide to.