Why Do Companies NOT Pay Dividends? It’s a good question that new investors often ask me. And since high dividend yield companies are usually so sought after, there is a lot of value in learning when it makes sense for companies NOT to pay dividends.
So read this short blog post to discover the hidden costs of high dividends, as well as when it makes sense for companies not to issue a dividend to shareholders.
The Reason Companies Do Not Pay Dividends:
As we discussed in the stock buy back article, companies are always under pressure to find high return ways to deploy the cash they generate. Management is always looking to reinvest these operating profits to earn a high return. If management has many demands on the capital the company generates it may not make sense to issue a dividend for shareholders.
So basically the reason companies do not pay dividends is because they have other uses for their cash. By reinvesting their money into the company (instead of paying it out to you in a dividend) they can continue to grow the company and increase future earnings. In the long term, these reinvested (rather than distributed) earnings will add much more value to shareholders than a simple dividend.
On the other hand, when companies slow down their growth or they have matured to be market leaders, activist investors and shareholders might be more insistent on a dividend because as growth plateaus there are less cash requirements. AAPL is a contemporary example of a company that did not pay dividends until recently, in order to placate some antsy investors.
Cash Demands Stop Companies From Paying Dividends:
There are a wide variety of reasons companies do not pay a dividend. But all of them have to do with other demands on cash. Common reasons cited by management for not paying a dividend might be that the business is capital intensive and requires a lot of ongoing cash infusions to improve operating efficiencies and keep plant and equipment up to date. Or maybe the company does not want to pay a dividend because they need cash on hand for acquisitions.
And on that note…
Fast growing companies do not often pay dividends either, because they want to conserve their cash and reinvest it for future growth. In this case the company hopes that by spending on R&D, headcount, and other growth initiatives they will increase the earnings of the company which will grow the stock price. If the company is indeed growing and earning a strong return on shareholder equity, then a 2-4% dividend yield is not much of a factor because your capital gains will be much larger than that. Does that make sense?
Some Investors Do Not Want Companies To Pay Dividends:
There are literally thousands of companies you can invest in on public markets. So the thing about investing in stock ideas is that as long as you know what you’re looking for, you can usually find something that suits you. And while dividends receive a lot of hype, they are not the most important factor for everyone.
Companies who do not pay dividends may be more likely to attract younger investors, whereas blue chip dividend payers will attract older investors who are looking for some investment income to supplement their pension or social security. It’s understandable why the latter type of investors are interested in companies that pay dividends, and why they would be mad if a company stopped paying a dividend.
On the other hand, if you have years of investing a head of you, you might want to find some companies that do not pay a dividend but provide high growth opportunity. Your investing results are likely to be more volatile in the short term, but the chance for long term capital appreciation is compelling. Thus, whether or not dividend payments are best for you will depend on your personal investment situation.
So I hope this blog post has helped you understand why companies do NOT pay dividends, and what it means for you as a shareholder. So now let me ask you, what are your favourite non-dividend paying companies?
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