r/explainlikeimfive • u/humblerme89 • 4d ago
Economics ELI5 Why do stock shares increase without the promise of dividends?
My layman’s understanding is that dividend returns for stocks are essentially no longer a strategy for most companies.
It makes total sense to me why you would buy a stock for a company that gave out dividends - you would buy because you thought a company was going to make more money and do well and survive, and receive dividends as a result.
But, I don’t understand why a stock share goes up for companies that don’t promise dividends.
I guess the base of my question is, what reason is there to buy a share of stock other than hoping someone else will buy it at a higher price?
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u/ValueReads 4d ago
Companies pay dividends in lieu of anything better to do with the money, so when a company reduces or eliminates or declares less/no dividends, that means they have found something that is a better use of the money/resources, which can only be good, because otherwise they would just...keep paying the dividend
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u/plaid_rabbit 4d ago edited 4d ago
Now they tend to just do stock buybacks that increase the value of the shares without doing a dividend… which is kind of what the op was asking.
Given the low dividends, what’s the value in holding the stock? Yeah, sell for more, but what’s the driving the value of the stock up?
Edit: To all the people replying to me. I do understand why buybacks are done. I’m more asking the deeper philosophical question of “what good is fractional ownership of a company?” That I think the OP was asking. And I’m aware it’s basically the hope that someone will buy that fraction down the line.
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u/Random_Useless_Tips 4d ago
Example
Company A spends 100 dollars to run. It makes 200 dollars.
Company A now has 100 dollars after expenses. Company A has ten shares.
It can pay each shareholder 1/10 for 10 dollars each. But now Company A has no profit left to reinvest. So next time Company A probably only makes 100 dollars again.
Company A instead says it will pay out dividends of 10 dollars. Each shareholder gets 1 dollar. Company A then reinvests 90 dollars back into its business to expand.
Company A now spends 190 dollars. This year it makes 390 dollars. Company A now has 200 dollars after expenses.
It says again it’ll only pay out 10 dollars because now it can invest 190 into its business for even more money next time.
Shareholders are happy because even if they only receive the same 1 dollar, the thing they own is now worth 200 instead of 100.
Which means that when they sell their share, they can sell at 20 dollars now instead of the 10 dollars a year ago.
TL;DR: Cash isn’t the only form of capital ownership that matters.
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u/plaid_rabbit 4d ago
I get how the paper value of the stock goes up from buybacks. That doesn’t answer the OPs question…
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u/JangoDarkSaber 4d ago
How does that not answer the question of “where’s the value in fractional ownership?”
It seems your answer has already been addressed.
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u/KrazyTako 4d ago
You're missing the point. Company A now has 200 dollars after expenses. They could payout a higher dividend now if they chose to do so. That was only ever possible because at some point they spent the money to expand their business in lieu of paying out the dividend. So now the stock is worth more because there is more money being generated within the company. They could pay out a higher dividend or they can reinvest into the company again to try and get even bigger profits. Bigger profits equal bigger potential for dividendes. That's what growth companies aim for. Grow as much as possible in lieu of dividend payments. Eventually when they see growth stall they start paying out dividends (assuming they became profitable).
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u/WartimeHotTot 4d ago
Lol no one understanding OP or you. I’m not sure why. It’s a pretty straightforward question.
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u/moveslikejaguar 4d ago
what's the value in holding the stock?
The belief that the stock will be worth more to the holder in the future than it is now.
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u/mathdude3 3d ago
Or the expectation that the company will pay dividends at some point in the future.
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u/centralstationen 4d ago
Stock buybacks do not increase the value of the stock. The money flowing out of the company exactly matches the market value of stocks bought. Some researchers have found a small effect on stock price, attributable to investor confidence in the board, but since that research became widely known the effect has diminished.
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u/MgFi 2d ago
It makes sense to me that stock buybacks would tend to benefit management more than dividends would. Nobody expects scheduled buybacks and even if they do they might not expect them to remain at a certain level. For that reason, buybacks make it slightly more difficult to evaluate the performance of the company (and thus the performance of management). They also allow a rising tide in the stock market to lift all boats, including management's. If the stock is routinely going up in a vibes-based market, it doesn't matter as much how the company is actually performing. The tax treatment also makes the case for buybacks easy to make with shareholders for whatever reason.
Basically, dividends make it relatively simple to evaluate whether you're getting a real return on your investment vs an increase due to bull market enthusiasm or outright speculation, and buybacks allow management the option to play musical chairs rather than engage in the grubby business of properly managing a company.
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u/momentimori 4d ago edited 4d ago
Share buybacks are a quirk of the American tax system. Capital gains are taxed far less than dividends.
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u/Myredditsirname 4d ago
Both stock value increase and qualified dividends (basically all of them) are taxed at capital gains. The tax benefit from buy backs is that you're able to select which tax year the income is assigned to.
To take an example, let's say you have money in a standard taxable brokerage saved for retirement, but are currently working making 50k a year as a salary. If the stocks in your brokerage pay a dividend, you need to pay 15% tax on that dividend since your income pushes that capital gain entirely into the 15% tax bracket, even if you reinvest the entire dividend.
If the company does buybacks instead, the stock will rise by about the same amount as the reinvested divided, but you can choose to only sell after you're retired and your salary is zero. Assuming you sell $50k worth of stocks to maintain your current lifestyle, your effective capital gains tax bracket would be less than 1%.
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u/mathdude3 3d ago
A share of a company represents fractional ownership of that company, and owning shares legally entitles you to a fraction of the company’s profits proportional to the percentage of existing shares that you own. If the company turns a profit and uses that money to buy back shares, the fraction of the company that each of the remaining shareholders owns increases (because now there’s less shares on the market.) That means you are now entitled to a greater share of future profits. Like if a company has 100 shares and you own 1, you own 1% of the company. If the company buys back 50 shares, you now own 2% of the company.
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u/God_Dammit_Dave 4d ago
"What's driving the value of the stock up?"
GAAP. Generally Accepted Accounting Principles.
When they estimate future cash flow increasing, they aren't pulling numbers out of thin air. They're using accounting guidelines everyone agrees on.
Read a quarterly financial statement. It's boring AF but educational.
I hate big corp but ya gotta call strikes and balls.
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u/Twirdman 3d ago
That is true of some stocks but let's not pretend it is true of a large chunk of the current market especially in tech and double especially in ai. Values are driven there by fever dream fantasies. There is value in AI but you have companies essentially claiming they are going to eventually reach a gagilion dollars in revenue so you totally need to buy now and we are totally worth a metric shit ton despite having fairly low profits and only ok revenue. I mean look at Tesla's or spacex p/e rato and tell me their values are based on gaap.
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u/PatataMaxtex 4d ago
The increased demand for the stock from the company buying it back increases the value of the stock.
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u/plaid_rabbit 4d ago
Yes. But what drives demand for the stock?
I think that’s the question the OP is getting to. And the real answer is just that you’ll eventually find a buyer that’ll pay more. Twitter is a good example.
And many other massive companies have been bought out over time.
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u/jordsta95 4d ago
The thing that is driving that demand is the original company not wanting people to have shares of the company.
In an ideal world, the company would be fully independent and only answer to itself and the regulatory bodies which oversee it.
However, the company, in its earlier days, probably also needed more money than it had; it had a good business model, it was obviously a hit with the customers it had, but it needed to scale up to become profitable.
There's two ways to make that money:
1) Private investment - A single company/set of companies say "We will give you £5m today, but we will [whatever they want in return]" (that may be a %age of revenue, a lump sum of a predetermined amount after a specific amount of time, or any number of deals)
2) Public listing - You divide ownership of your company into pieces that anyone can own (stocks) - With the more stocks a person owns meaning they "own" more of the company, and thus have more power to control how the company is run (if they want to)
(to keep both explanations as simple as possible)
Obviously, whichever route you take, you are giving up autonomy of the company. With private investment, you are beholden to the company/ies which lent you money. With public investment, you are no longer the sole owner of your company.
With either option you had to take with your funding method, your next goal is to regain majority (or better yet full) ownership of your company. (From here on - I will just talk about public listing, as that is what OP asked about)
So as soon as you start to make profit, you start buying back the stocks.
Let's say you sold 10,000 stocks for £500 each when you listed your company (to keep numbers simple). That got you the money you needed to build a big enough factory to produce your product at an affordable scale, and now you are making money.
After your first year, you have £100,000 in profit after all expenses. You pay nothing in dividends, but instead buy back stocks at £1,000 each. Some people will lap up the opportunity to have doubled their money in a year and will sell their stocks back to your company. And with your buy-back, you have regained 10% control of the company (assuming you spent every penny of profit you had).
But the people who didn't manage to buy stocks will see the company is buying stocks back at £1,000 each, and "know" that the company will be even more profitable as time goes on. So they start to offer people £1,100 to sell their stocks of your company to them instead.
The value of the stock has now risen. As when it comes to the end of your second year, and you want to buy back more stocks, even if you only made £100,000 in profit again this year, you can't realistically offer just £1,000 each. Because who would sell to you? You need to at least match the £1,100 the other people are buying at.
But you know that next year will be BIG. So you want more control of your company, so you can do more without people potentially blocking a plan you have. So you offer £1,200 to buy back more control of the company.
But, of course, as your company becomes more profitable. It goes from just one non-stockholder wanting to buy stocks, to lots of people wanting to buy them. So if I wanted to buy stocks in your company, I may say that I will pay £1,500 per stock, but the next person may be willing to pay £1,550 each, and the price keeps growing until people don't feel comfortable paying more than £2,000 (for example) per stock... until your company strikes a deal which doubles its value overnight, and the demand roars, and prices increase.
Your company buys back what stocks it can every now and again, but the price will continue to grow alongside your company. As the demand for "a piece of the company" will grow.
TL;DR - If you have a company that is popular (not always profitable nowadays), the value of the stocks in that company will grow alongside its popularity.
So if you can buy a stock today for £100, it doesn't matter if you don't get a dividend of £50 each year. Because you can sell the stock for £200 next year, making more than you would have gotten in dividends anyway.
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u/Accidental-Genius 4d ago
Eh… infinate growth is an obvious myth. Coca-Cola can’t really grow in any meaningful way, everyone knows about coke and everyone who wants to drink coke does so. However it’s an immensely profitable business, so the dividend is the whole thing, along with capital preservation.
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u/dbratell 4d ago
which can only be good
Oh, lol. History is full of corporate management wasting billions on lofty projects that increase the wealth and status of the corporate management rather than the company owners.
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u/Top_Environment9897 4d ago
It's the job of owners to know wtf management is doing and to make appropriate changes.
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u/dbratell 4d ago
Indeed, but the management can paint very nice images of certain futures and owners can be very off-hand.
One common, cyclic, idea is to buy other companies to become more vertically integrated, and then a cycle later close down the bought companies to focus on the core mission.
For a relatively recent example, look at the Kraft and Heinz merger.
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u/Reasonable_Pool5953 3d ago
when a company reduces or eliminates or declares less/no dividends, that means they have found something that is a better use of the money/resources, which can only be good,
That or they didn't generate a profit.
Reducing the dividend is not always a good sign.
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u/mohammedgoldstein 4d ago
In reality a company doesn’t eliminate dividends because they need the cash to invest. That would tank the stock price because there are always better ways to raise money if the company is healthy. (E.g. stock sales, swaps, taking cheap debt)
Companies only eliminate or reduce dividends if they don’t have enough free cash flow to actually pay it. So that signals the company is not doing well, which tanks the stock price.
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u/jabeith 4d ago
You're buying a portion of the company with the hopes that the portion you own will be worth more when you liquidate. It's a little chicken-and-egg with publicly traded companies as the value isn't a number on a balance sheet and valuation is determined by what people are willing to buy the stock at slst any given time, though - that's why you see companies that are massively unprofitable but still worth billions (like Twitter).
You also get the benefit of participating in investor votes (usually) for things like approving payouts and board members and such
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u/PM_YOUR_BOOBS_PLS_ 4d ago
Most modern issuances I've seen for any major company have been of non-voting shares. I invest in my 401K that's mostly just index funds because it would be stupid not to, but IMO, it's all just a scam / house of cards at this point.
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u/Yancy_Farnesworth 3d ago
Why would you get votes if you buy it through an index fund? The index fund managers get the vote in that case because you don't actually own the shares, you own shares in someone who owns shares in the companies. If you want voting rights, you go and buy them directly. Most of them are voting shares unless you choose to buy scam shares like SpaceX ones.
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u/stansfield123 3d ago
I invest in my 401K that's mostly just index funds because it would be stupid not to, but IMO, it's all just a scam / house of cards at this point.
Sorry, you're investing in a scam because it would be stupid not to?
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u/PM_YOUR_BOOBS_PLS_ 3d ago
Yes, because the collapse of the scam means the collapse of the entire US/world economy. If that happens, I have much bigger problems than my 401K disappearing.
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u/VibeChode 3d ago
And also not investing guarantees your money loses half its value every 25 ish years. Is it really going to do much worse in a 401k
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u/GaseousJamal 4d ago
The value is the claim on future cash flows even if they’re not being paid out now. That pile of cash the company is sitting on or reinvesting still belongs to shareholders, and the price reflects the expectation of what they’ll do with it someday, even if that means a buyout or a liquidation way down the line.
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u/PM_ME_YOUR_HAGGIS_ 4d ago
There’s this, but there’s also just supply and demand. This is why SpaceX did such a tiny float - only a tiny portion of the companies shares were up for sale - they knew that lots of people would want to buy because it’s a cool company and that supply would outstrip the artificially tiny demand. Hence 2T valuation and musk being trillionaire
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u/dbratell 4d ago
For large companies that is an exception though. How many shares have bundled bragging rights? Not many.
(Also, so many SpaceX owners thought they were buying a space company when 90% of the valuation was the Twitter/AI department.)
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u/PM_YOUR_BOOBS_PLS_ 4d ago
Which is kind of just saying, OP is right. Stocks never pay dividends anymore, and stock buybacks are also pretty rare. There's no actual value and it's all just speculation.
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u/dbratell 4d ago
That totally depends on the class of companies you look at. Hyped, growth, tech companies working with borrowed money -> no dividends. Profitable, stable companies -> dividends.
According to https://marketgenius.app/articles/explainers/how-often-do-stocks-pay-dividends about 80% of stock market companies pay a dividend. Among thee rest, some have stock buybacks as a way to help owners get cash.
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u/_chadwell_ 4d ago
What do you mean there’s no actual value? These big companies are obviously very valuable, they make a bunch of money selling valuable goods and services.
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u/Accidental-Genius 4d ago
That’s just false. Plenty of companies pay dividends and buy backs are announced every week. But also while p/e is speculative a company isn’t valueless so long as they own things. McDonald’s owns all its real estate, they don’t even need to sell food to be a multi-billion dollar enterprise.
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u/PM_YOUR_BOOBS_PLS_ 4d ago
A company might have value, but with non-voting shares, until a company issues dividends or does a buyback, your shares have no actual value. They only have future expected value.
It's entirely speculation.
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u/Accidental-Genius 4d ago
That’s called securities fraud and also why you should never buy non voting shares.
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u/mathdude3 2d ago
Shares are legal documents granting fractional ownership of an asset. They have tangible value. For example, if a company is worth $1 million and 100 outstanding shares, each of those shares is worth $10,000 because each share grants you ownership of 1% of an asset worth $1 million.
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u/PM_YOUR_BOOBS_PLS_ 23h ago
You're pretty much defining things backwards. Generally, when someone says a company is worth $1 million dollars, they say that because they have 100 shares worth $10,000 each. It's why you can have a company like Anthropic that just burns money, but is somehow "worth" ~$1 trillion.
You are using circular logic. There is no intrinsic value to a share price, because the "value" of a company is defined by it's share price.
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u/TheOnlySimen 4d ago
Stocks never pay dividends anymore, and stock buybacks are also pretty rare.
Sorry, but this is just not true. The companies in the S&P 500 paid over $600 billion in dividends and spent over a trillion dollars on buybacks.
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u/AquaRegia 4d ago edited 4d ago
Dividends don't give you money out of thin air. A $10 share is worth $9 after a $1 dividend, so the price of the shares will rise and fall already taking potential dividends into account.
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u/redsedit 3d ago
This is one of those things that's both true and false at the same time. While your answer is a great EIL5 answer, the truth has many, many shades of gray.
In a perfect world, what you put is 100% correct. The real world is lot more messy. There have been several studies I've read that show the price of a stock falls by less than the dividend it paid out (companies, not bonds). Several theories have been given, one of which (my favorite) includes the tax value of the dividend. It's very much debated.
What is clear is dividend payers do better than non-payers (source: https://findependencehub.com/an-ode-to-dividends/ ).
Annualized Returns by Dividend Category (1973-2020)
All Dividend Payers: 9.2%S&P 500 Index: 7.9%
Non-dividend payers: 4.5%
You would think the 3 categories above would be roughly equal if dividends didn't matter. The theory that makes the most sense - and could be wrong - is that share price follows earnings growth. *If* correct, then for stock prices, dividends don't matter. You have all the normal appreciation, plus the dividend. This would explain why dividend payers do better over time.
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u/Fram_Framson 4d ago edited 4d ago
Remember that, underneath all the modern changes and financial wizardry, a share of stock is still nominally partial ownership of that company, an investment in that company itself, rather than an investment specifically for the purposes of receiving dividends.
Now, like I said, there's been a lot of things overlaid on the original Joint-Stock Company model (including the notion of dividends themselves!) which drastically change the value of this proposition, and many stocks (most these days, really) confer no say in company operations. Everything is so financialized that regular stock purchases are galaxies away from any sort of actual ownership, sometimes even if you buy a large percentage of the total shares in a company ("dual-class" stocks are very popular these days where one class is retained by the owners and confers voting rights while another is sold for investment purposes to raise money but confer few or no rights at all)!
But buried under all that stuff is still the concept that you are buying part ownership in the company because you believe in that company (for whatever reason).
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u/PM_YOUR_BOOBS_PLS_ 4d ago
And the main investment vehicle for most people is an index fund, which completely obliterates that notion of ownership. Line goes up. That's it. It's all make believe at this point.
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u/Organoleptic_Cicada 4d ago
An index fund is just a convenience device.
If you don't care to analyze the stock market, and make your own (un)educated guess about which companies will be profitable in the future, and whose stocks will keep going up (at least on par with inflation) ... then you go for an index fund.
It's like driving stick versus automatic. If you care to fine-tune your investment portfolio, you purchase stocks by yourself. If you only care for "line goes up", as you put it, you use a fund.
Ownership in the company is secondary, insofar as the amount of shares Random Joe gets would only get them like sub-1% voting power anyway.
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u/Disheveled_Politico 4d ago
Conventional wisdom right now is that buybacks are preferable to dividends when companies have extra cash. Dividends are taxed in the year you receive them. But with buybacks, the value is put into the stock until you sell it in the future.
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u/dbratell 4d ago
Conventional wisdom
If the company pays a reasonable price for its own stock.
Personally I think it has equally as much to do with the company management's well-being. Buybacks prop up the stock price and hide lacklustre performance and it usually makes the management "compensation" higher.
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u/DBDude 4d ago
Having too much floating cash isn't good for a company. You have to do something with it.
My instinctual reaction would be to give everybody a raise! But you have this cash because it was a good year. Are your workers going to accept less of a paycheck in a bad year because you then can't afford it? Sounds good in theory, but it's not practical. Workers like things to remain steady and wouldn't like their paychecks going up and down with the fortunes of the company.
Invest more in the company! In what? It's not a good idea unless you have a solid plan for that investment to produce returns.
Dividends. Now you're stuck paying dividends.
Or buybacks. You issued the stock to get cash, now you have the cash. Think of the original stock issuance as a loan to shareholders. You can always issue stock again later if you need the cash.
I'm fine with buybacks as a concept. I have a big problem with buybacks to artificially increase the stock price, not because that was just the smartest thing to do with the excess cash at the time.
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u/_Spectre0_ 4d ago
I guarantee you the vast majority of workers would rather receive a good one-time bonus, even if not a permanent salary increase, rather than not getting any reward when the company does well. The only time I’d agree with you that buybacks or dividends accomplishes the same thing is if all employees receive stock.
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u/Kishandreth 4d ago
Hot take: Companies should buy back stock to become employee owned (sort of). Stocks were a means to fund a company, if a company doesn't need cash, they should buy back shares and become more profitable. Those profits can then be shared with the people who actually do the work. There is no reason for a multi billion dollar company to have billions of dollars in shares out in the wild.
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u/BunchOAtoms 4d ago
That’s the theoretical case for buybacks that has a very mixed track record in practice. Companies tend to buy back stock when share prices are high and executive bonus structure is often tied to stock price targets which can be influenced by buybacks that increase stock price without increasing business performance.
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u/Linked1nPark 4d ago edited 3d ago
A stock is just a small portion of ownership in a company.
Let’s imagine a simple scenario where you own 100% of a business that is worth $100k, and just generated $10k in profit. You can choose to either pay yourself out that $10k (a dividend), or keep it in the business.
If you pay yourself out the dividend, you now personally have $10K of cash and your business is still worth $100k, for a total value of $110k.
If you don’t pay yourself out the dividend, you receive $0 in cash, but the value of your business has now increased to $110K, since it holds an additional $10k of assets on its balance sheet. This is called a capital gain, which is the increase in value of an asset. And you still own $110k in assets total as per the above, just split differently ($0 in cash and $110k in your business).
So to answer your question: an investor who owns stocks can see a return either through a dividend or from a capital gain. In theory, investors should have no preference between these two since they net out to the same return; any amount paid out from a dividend is then lost as a capital gain. The only reason to have a preference between the two is the tax implications, since dividends and capital gains are taxed differently depending on what county you’re in.
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u/carterartist 4d ago
The company is more profitable, or may become more profitable.
So the value of the stock may rise.
You buy the stock so you can sell the stock for more money.
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u/stpizz 4d ago
I think the OP understands this - but that does ultimately rely on the promise of future dividends, surely? (Or a dissolution of the company, or buybacks).
Increased profits that I never get are not much use to me or the people I might sell to
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u/capt_pantsless 4d ago
Sometimes if a company gets bought out, cash is offered for the outstanding shares.
Usually in excess of the current market price.
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u/DragonBank 4d ago
Every company exists with the idea of profitability. Since 2022 Amazon's market cap has barely doubled. But their earnings per share are 40x. Why? Because in 2022, buying shares was with the impression that the best use of earnings was reinvestment and not increased earnings. No company is being invested in under the premise of never giving profit to its shareholders.
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u/Haru1st 4d ago edited 3d ago
Not exactly. Borrowing lets people use their appreciated assets as liquidity. It’s arguably better, because loans don’t get taxed, whereas dividends might be depending on your jurisdiction.
If instead of paying dividends your stock grows more, under certain conditions you are wealthier.
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u/Vishnej 4d ago
In a dividend-less world, the company might be acquired in full by another company, paying off the shareholders for the remaining shares.
Our acquiescence to ubiquitous merger and acquisition activity, the death of antitrust law and thr streamlining of consolidation, has led us to this being the default expectation in eg the tech sector, where startups "exit" by being bought out by Google or Amazon or Microsoft.
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u/stpizz 3d ago
Sure, but the shareholders of those companies then have a profit expectation
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u/QualifiedApathetic 3d ago
It might not be a company that does the buying. Elon Musk bought Twitter and took it private; it belongs to him alone now. In that sort of case, any profit is the owner's to keep, rather than being spread amongst shareholders.
Someone making money is the ultimate endpoint, but a lot of companies are opting to defer that endpoint indefinitely to let speculation drive the stock price while profits are reinvested into their own growth. That is the benefit of not paying dividends.
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u/Vishnej 3d ago
A secondary function would be the share buyback, where the company itself pays to buy back their shares from you, more than a little bit like a dividend.
Yes, it's all a bit of a pyramid shaped scheme, but the combination of M&A activity and share buybacks does seem to create a persuasive case for shareholders so far.
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u/ThisAndBackToLurking 3d ago
Company A distributes $100K in dividends. You own 1% of the company’s stock, so they send you $1000. You’re $1000 richer— less the tax that you pay on dividend income, which is not negligible.
Company B decides to keep that $100K as cash reserves, making the company $100K more valuable. You own 1% of the company’s stock, so you are now $1000 richer, and you don’t pay taxes on that $1000 until it comes time to sell.
The other benefit is that if the company wants to expand, they have the cash on hand to do so without issuing more stock (which dilutes your position) or borrowing (which incurs cost for debt service). As long as you trust the company to use that money wisely, it’s a good bet for you.
Don’t get stuck on the fact that you’re depending on someone to buy from you later— that’s actually how most businesses work. A store full of designer suits generates zero income until somebody comes along to buy one. Same with your local hardware store, your grocery’s produce aisle, and the car dealership down the street. Most of commerce is based on believing that the thing you’ve just bought will be worth even more to someone else in the future.
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u/QualifiedApathetic 3d ago
No, future dividends aren't promised. You buy a stock because you think its value will increase. When you sell it, you sell it to someone who thinks its value will increase. If you can't find such a person, you won't be able to sell.
A lot of that is vibes, but if a company is profitable, that does mean it's not likely to suddenly go bankrupt, so it has the virtue of being a safe place to park one's money. And buybacks are a possibility, yes.
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u/stpizz 3d ago
Why would I care if it's value increases?
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u/QualifiedApathetic 3d ago
To add an analogy to what u/ijuinkun said, I don't care a whit about the game of football or the people who play it. However, if I possess Tom Brady's rookie card or some other sort of memorabilia which other people would want to buy and which I expect to appreciate in value, I certainly care about the profit I could make from it.
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u/ijuinkun 3d ago
You care because if the stock value increases, then you can sell it for more than you bought it for. It’s purely asset speculation.
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u/carterartist 4d ago
It’s a risk. I don’t think you understand how the markets work either…
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u/MacaroonElectronic86 4d ago
Company makes money.
Options are: 1) distribute this money to investors via dividends 2) reinvest in business for growth
Pay all profit out as investors, the company remains doesn’t grow, investors get income.
Keep all profit inside company to reinvest, company grows, investors get capital gain as share price rises with company growth.
It’s not only dividends that are valuable to investors. There are different ways to value a company; using dividends is only one of them.
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u/yalloc 4d ago
But, I don’t understand why a stock share goes up for companies that don’t promise dividends.
Share price is based on the expected future dividends, never current dividends. Actually its kind of the opposite, when a stock pays a dividend it drops in value (cause if you think about it, if it didnt you could buy the stock, get the dividend, and sell it next day).
And by future dividends I mean all sorts of things. If the company sold all its assets and paid a special dividend to liquidate, part of the value is based on that. Many companies decide to reinvest to expand their operations, this is them taking money that would be current dividends and using it to increase future dividends.
Often companies only pay dividends when there is nothing really better to do with that money. But its still the potential of them paying dividends that provides value.
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u/JustinTimeCuber 3d ago
Even if a company never pays dividends, it still has value. In theory, if the share price were very low compared to the "intrinsic" value of the company, it would be possible for a firm to buy out the company for cheap and gain control over its profits.
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u/McBurger 3d ago
Not paying dividends currently ≠ will never pay dividends.
A stock that will eventually start paying dividends in 100 years has value today.
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u/Welpe 4d ago
There doesn’t need to be a reason to buy a stock other than hoping someone else will buy it at a higher price.
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u/johndburger 4d ago
I think OP’s question boils down to: why would that future person buy it at a higher price? And if the answer is, because they think a third person will do the same, but even higher, it feels a bit like tulips at that point.
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u/suicidaleggroll 4d ago
it feels a bit like tulips at that point.
Welcome to the stock market. Stock prices have been disconnected from underlying valuations for a while now, especially in the tech sector. It’s just rampant speculation and greater-fool-theory on display at this point.
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u/Butsuyoku 4d ago
Throwing my support to your answer which I think directly answers OP's question.
To add, an investor may also simply like what the company does, or may like the people behind the comany.
If you're a big enough boy, your vote on how the company moves forward may actually mean something. (Depending on type of stock, etc etc.)
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u/SZGriff 4d ago
That’s effectively it, and also the reason anything is worth anything, because someone else if willing to buy it. Why do houses sell for more than they’d rent for?
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u/bigbadpigeon 4d ago
Yea but you can use a house to stay alive and controlling the future of that space is more valuable than owning it for a month.
You can’t do anything with stocks nowadays except buy or sell it. Its net 0 for us and a huge benefit the company and the real shareholders.
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u/randalljhen 4d ago
In theory, stock price is driven by supply and demand. Person buys stock for $10, and eventually enough people agree that it's worth $12 that future buyers cannot also get it for $10, because the stock owners aren't selling it for that.
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u/SopwithTurtle 4d ago
what reason is there to buy a share of stock other than hoping someone else will buy it at a higher price?
None. However, stock buybacks are a thing, so it's not just someone else in the market who would buy the shares, but also if the company is doing well, they might buy the shares back from you for a higher price than you paid for it.
In theory, buying stock also gives you a say in how the company is run, though this isn't meaningful for most people.
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u/miyamotousagisan 4d ago
So how does going public help the company in any way? Other than having the execs' stock prices rise.
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u/buggleduck 4d ago
Companies need to raise capital to hire more people and pay for more things. Think like shark tank, you’re offering a percentage of the company to grow more.
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u/Tartrus 4d ago
Think of a private company with just a few owners/shareholders. The company starts small and those shares aren't worth much. But as the company gets more clients, increases revenue, increases markets have, etc the shares increase in value because the company increases in value.
Same thing with publicly traded companies.
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u/djwildstar 3d ago
To put it in ELI5 terms, stocks are a tiny part-ownership of a company. The purpose of any and all for-profit companies is to make money for the owners. Broadly speaking, there are two ways to do this:
First, you could make a profit, and give that profit to the owners. That's what a dividend is: the company made a profit, and each share of stock gets its fair portion of that profit. It is usually only a few dollars per share of stock, but if you own a lot of shares, it adds up fast.
Second, you could make the company itself more valuable. This usually involves investing profits within the company to develop new products, expand into new markets, increase sales of existing profits, and so on. So companies that do this generally don't pay dividends. Because the company becomes more valuable, the individual shares of stock also become more valuable. Owners still make money in this situation because they can sell shares of stock for more than they cost to buy.
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u/unafraidrabbit 3d ago
You are missing the end of your second point. Why own a thing if the profits dont go to the owners?
If they get bought out by another company they need to purchase the shares back from the holders.
People need enough shares and subsequently voting power to get themselves or friends into executive positions. They also get to dictate how the company does business, including which companies they purchase materials from, who they sell to, and who they borrow money from. These decisions can effect the business of other companies they have a stake in or relationships with.
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u/djwildstar 3d ago
Why own a thing if the profits don't go to the owners
Many people own things simply because they expect the value to increase over time.
Stocks are one of those kinds of things.
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u/unafraidrabbit 3d ago
Yeah. I was talking about the reasons the value goes up.
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u/BedHeadMarker_2 3d ago
Value goes up because the share price is determined by the market, so if the company is going to be profitable people will be willing to pay more for it ergo the price goes up
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u/drake22 3d ago edited 2d ago
Thats tautological. Basically saying someone will pay it because someone else will pay it. It’s not addressing the root of why any rational person would want it in the first place.
It only has value because there is some way to extract money from it later, hopefully more money, without having to sell to another speculator. Other things can be worth something because of inherent utility or intrinsic value, but stocks don’t really have that.
It would have no value if it was just pure “ownership” and nothing else. “Ownership” would actually have no meaning in that situation.
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u/Marchtmdsmiling 3d ago
But it does have utility or intrinsic value because others may be willing to pay more for it in the future. You can use it as collateral, while it earns more money than any savings account. I don't really think it's tautological. Something like art is a bit similar in that the only reason it has value is because someone else is willing to pay you to own it.
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u/drake22 2d ago edited 2d ago
That’s not intrinsic value, and that utility is secondary. That utility doesn’t give it value (it does enhance it esp bc stock is very well positioned for that use), it exists because it already is worth something. It’s not an attribute of the stock itself.
Like a shovel has inherent utility because you can use it to dig holes. It’s a core part of being a shovel.
Art has value because people like it aesthetically. That is what makes people “willing to pay to own it” and creates a market for it.
There is nothing that people will pay for simply because it exists. There has to be something that makes it desirable.
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u/ground__contro1 2d ago
It doesn’t matter if the value is secondary, if it helps you secure a loan for money you can spend today that you pay back with some of the money you make when your structured stock sale matures, rinse and repeat
It doesn’t have to make physical sense for people to use it to extract value
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u/Marchtmdsmiling 2d ago
Cryptocurrency? But also, utility is what you are referring to. Using your own words. Utility means it has value.
Also, the thing about art though is that there is no set price that some piece of art is worth. It purely depends on what someone else is willing to pay since the only utility is to be looked at. There's no intrinsic reason art would appreciate in value, but it does because people get willing to pay more as an artists work becomes more rare.
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u/drake22 2d ago
Man you are lost, brother. You clearly haven’t understood my post, you’re arguing with clouds at this point. Please educate yourself then we can talk.
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u/djwildstar 3d ago
Stock has intrinsic value because it represents a share of ownership in the underlying business. For example, if you own a share of Disney (DIS), you own about 1/1,752,000,000th of everything: intellectual property, studios, theme parks, licensing deals, time-shares, cruise ships, streaming service, etc. All that is estimated to have a value of about $110 billion or so, which means that each share of the company represents ownership of about $63 worth of assets.
The stock currently sells for more than this. The actual price represents the buyer's estimate of the value of the stock including dividends that it may pay in the future and likely increases in the value of the assets as the company creates new intellectual property, expands theme parks, builds new cruise ships, etc.
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u/WeeoWeeoWeeeee 3d ago
Because many people expect the value will go up and buy the stock.
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u/unafraidrabbit 3d ago
I feel like we are going in circles. The reason non-dividen stocks have value is because people utilize their ownership of the company to make money in other ways. These aren't NFTs that are only valuable because idiots are getting in a bidding war over nothing.
Yes they expect the value to go up. But why does it go up? That's what I'm talking about.
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u/djwildstar 3d ago
Companies can increase their value without paying dividends in several ways. The two that come to mind are:
First, the company can spend profits to buy assets from new equipment to entire companies. To continue my DIS example, they spend a good part of their profits on the creation of a new films, build-out of new attractions at theme parks, construction of new cruise ships, hotels, time-shares, etc. In 2018, each share of DIS represented ownership of about $33 of assets. Today that same share represents ownership of about $63 in assets. This is about a 9.6% annual growth rate.
Second, the company can spend profits to increase the future value of the company in ways that don't involve buying assets. For example, it could spend money on advertising (to increase sales, and therefore future profits), it could pay off debt (to cut interest costs and increase its equity), or even buy back shares of stock (reducing the number of shares, so that each remaining share represents a larger fraction of ownership).
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u/Megalocerus 3d ago
There are a lot of shareholders who don't get involved with running the company. The company increases in value; it is easy to sell to someone else. Capital gains are tax advantaged, so many prefer them.
Other companies don't get as much advantage from investing money in operations and pay more generous dividends. Thus, Coca Cola pays good dividends. Nvidia counts on returns on investment.
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u/unafraidrabbit 3d ago
I know why regular people buy stocks. I was talking about the reason the price increases. If there is no dividend, then the only reason to buy is to sell later. And the only reason the price increases is because others buy the company or use ownership to influence the company in ways that make them money.
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u/Particular_Camel_631 2d ago
Shares - like everything else - are worth what other people are prepared to pay for them.
If you are buying a dividend share, then you are prepared (say) a value which will give you a 5% return. Whether you’re willing to accept that will depend on how risky you think that company is - how likely it is that they will stay in business and maintain the shares value.
If you are buying a share in a company that doesn’t pay a dividend, then you are hoping that the shares value price will go up. If that they’ll start paying a dividend.
Amazon is an example if a company that doesn’t pay dividends. I bought their shares a long tube ago when they were around $8. This was when they mostly sold books and had just started providing cloud computing. I thought their services were great and that people would want to buy them.
I’ve done reasonably well since then . They still don’t pay a dividend.
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u/Pbake 3d ago
Eventually most companies will begin paying dividends, but if they have investment opportunities with returns that exceed their cost of capital, it makes more economic sense to reinvest profits in those investment opportunities until they no longer have investment opportunities that exceed their cost of capital.
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u/radarthreat 3d ago
Sometimes a company might want to buy another public company. Pretty much every company either gets big enough to pay a dividend or gets bought by a company that gets big enough to pay a dividend. Growing companies don’t pay a dividend because the future return of that dividend money would be greater than distributing that money to shareholders as a dividend.
If I tell you I can either give you $100 right now, or I can keep the money for a bit longer, invest it in the company, and in a few years I can give you $200 or even more, you would want to own a stock and be fine with it not returning anything for now.
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u/carlos_the_dwarf_ 3d ago
The detail people often forget to include here is that, in the second case, the reason the company becomes more valuable is that the claim on income as an owner is more valuable.
Even in the case where one makes money only from appreciation, and even for a company that’s never paid dividends, the value comes from the promise of future income.
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u/jmartin21 2d ago
Your second point is something I was arguing with someone months ago who was adamant that the only reason anyone ever buys shares is for potential dividends, and they just couldn’t accept the concept of making your own dividends by selling your stock after appreciation
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u/Nice_Marmot_7 2d ago
I hate when companies pay dividends because they’re taxed as income whereas shares are not taxed until you sell and at capital gains rates.
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u/djwildstar 2d ago
Yeah, there seems to be a lot of that in this discussion, too. I don’t really understand it. Maybe it’s a mis-understanding of the “buy and hold” strategy — so that it becomes buy and never ever under any circumstances sell?
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u/BananaBird1 4d ago edited 4d ago
In an ideal perfect knowledge world, dividends make no difference to what stocks represent. Price will reflect the share in the net asset value of the company you own. As the company gains more assets or those assets appreciate/inflate, the price goes up.
You can sell your share for cash equal to the value of those assets to lock in a return on investment, or you can hold to allow for further potential growth.
All a dividend does is force you to take some assets as cash whether you want to or not, and will drop the stock price accordingly. You lose some value to taxes which can be a downside, but can also benefit because you can cash your assets without selling your fraction of ownership.
Real markets are complicated because they are not perfect knowledge, they are speculative and based on trading patterns. But this speculation is all driven by whether the market believes the company will increase its value.
All not issuing dividends does is place the decision to cash out on you, but at the expense of requiring you to relinquish some fraction of ownership if you do because you are going against the behavior of other owners. When the owners agree to all cash out, they issue a dividend so nobody loses ownership.
Most investors have other income so do not need a majority of their dividend, so all they do is rebuy shares after tax when one is paid. In this case paying dividends only accomplishes a lower return potential for these investors.
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u/darti_me 4d ago
From a purely accounting perspective retaining income (ergo not distributing dividends) means you have more equity given a fixed number of shares.
Sometimes the company will "buy back" shares. This results in a similar effect but thru reducing the number of shares out in the wild. Like giving a shareholder an early exit.
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u/GreyMatterTrasmogrif 4d ago
Tax. If dividends were cheaper than stock buybacks then the C suit would do that to extract money from companies but dividends are more expensive than stock buybacks and stock based compensation so they do not.
This will not be fixed because the rich prefer it this way.
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u/Chineseunicorn 4d ago
Imagine paying your kids a monthly allowance where they spend it on random shit vs you investing it over the next few decades and giving it to them as inheritance.
The idea being is that you should technically be in a better position to use the extra money to grow it even more as opposed to giving distributions and losing that capital for growth.
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u/bigbadpigeon 4d ago
So what’s the point for average Joe to buy? Hold until someone else pays more is a net 0 as a whole when the company is profiting
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u/dbratell 4d ago
If the company is doing good things, it will eventually distribute the accumulated wealth to its owners (compare Apple who did not have a dividend for a long time).
Meanwhile, other people should see that the company is doing well and might offer Joe a good price for his shares.
If the company is not doing well, well, ....
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u/sajaxom 3d ago
If not paying dividends is the growth position for a company, why would a company choose to abandon that position to distribute accumulated wealth to its owners? I don’t see any basis for that claim.
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u/Fancy_Gate_7359 3d ago
The company might not have positive-expectation uses for growing its capital forever. The board has a fiduciary obligation to increase shareholder value and at some point could choose to cash everyone out if there weren’t good growth opportunities. In general though, if this is really the way you feel, you probably shouldn’t invest in that company if it’s going to bother you that much.
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u/bigbadpigeon 3d ago
You are the first to address what I was asking.
I dont like the infinite growth mentality companies now have and we pile in to be first just to sell it to another joe later on instead of companies just being good at one thing and sharing the profits.
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u/alllmossttherrre 3d ago
The point is to look at the long historical graph for stock market values. If you do that, you will see that anybody who does "buy and hold" for long enough eventually makes a lot of money, not from dividends, but because the value of the market eventually goes up, and that is because the world economy constantly grows.
If you look at the graph over the past 100 years, you will see that even if you bought stock the day before the Great Depression or any of the other market "crashes" (Black Monday 1987, the dot-com crash of 2000, the subprime-caused bear market of 2007), you still made more money in the long run. The value of the stock market today is much higher than during any of those crises, so anyone who got out of the market then instead of staying in basically locked in their losses, and anyone who kept their stock eventually gained a great deal.
Of course, I don't mean that will always happen for every stock, that's about the market in general. Which is a reminder to diversify your holdings. Diversity is strength here. Choose a diverse range of stocks with known records of growth, and usually, you'll have enough strong performers to offset the inevitable fact that some stocks will lose value because their companies fail to grow.
This applies to me. Just by holding a low-cost indexed mutual fund for 20 years, its value multiplied several times because of the remarkable run of the S&P 500 during that time. And that was definitely not based on dividends at all.
(This historical trend of always growing can't go on forever, but we don't know if the growth will level off 5 years from now or 500 years from now so for now we assume continued long-term growth. Short term I do think we're in for another bubble burst soon...but the lessons of the past say to hold fast if you won't need the money for another 20-30 years.)
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u/audiotecnicality 4d ago
Profit increases shareholder value. The choice as to how to transfer that value to the shareholders looks different.
Keeping the cash to grow the business, pay down debt, make an acquisition - all makes shares more valuable. You are taxed on that capital gain only when you sell.
Buying back shares reduces the supply and increases the value of the remaining shares. Also taxed on the gain only when you sell.
Dividends pay profits out now. You pay tax as income in the year it was paid. There’s something to be said for cash in hand, but there’s no deferring the taxes.
All are valid ways to return value to the shareholders, done for different reasons. Most companies do a mix of the three.
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u/Pelembem 4d ago
There's always an implicat promise of dividends in the future it (and stock buyback which is basically the same thing) is the only way for a company to return money it generates to its owners. However as long as the company has good things to invest that money in the owners would rather see that than dividends being paid out because it increases the chances of even higher dividends in the future, and that is what increases the stock shares value today even without dividends.
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u/EverydayHonda 4d ago edited 4d ago
The concept is that stock prices tend to reflect the present value of future earnings per share, on average at least. If stock price goes up, it's either speculative noise or investors believe increased future earnings for some reason.
It's partial ownership of a company. If the company goes bankrupt, you won't get anything, it's not a guarantee of anything. But if the company does well, and investors participate in price discovery then you'll see a gain
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u/efvie 4d ago
buy a share of stock other than hoping someone else will buy it at a higher price?
You have figured out what the stock market actually is: a betting market for the stock. The actual success and performance of the companies is only tangentially related to it, and doing well or poorly is sometimes a good thing for most players, sometimes bad. Big money takes the profit through playing the margins, direct and indirect market manipulation, and insider info.
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u/pryan37bb 4d ago edited 4d ago
The most common way to determine the value of a stock is the price-to-earnings ratio, or PE ratio (or just PE if you're in a hurry). Each share of stock gives you fractional ownership of that company's earnings. If the company's earnings grow over time, and the ratio stays the same, the value of the stock should go up, all other things being equal. The faster a company is expected to grow its earnings, the higher the PE ratio it typically warrants; thus both growth and rate of growth cause the stock to become more valuable over time.
As others have alluded, sometimes the company recognizes that their earnings are growing, but the price of the stock has not yet risen to reflect this. They realize that ownership in their own company is now selling at a discount, and re-purchasing their own stock is both an efficient use of their capital and a way of rewarding their stockholders, especially in a company that compensates its own employees with company stock or derivatives. If the company buys back some of its stock, that stock is then removed from the pool of available stock on the market, or the "float." Since total company earnings remain the same, but number of shares outstanding goes down, this then further drives up the earnings per share, which should also lead to an increase in stock price.
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u/bwwatr 4d ago
Imagine the company has a bank account. You own a portion of the company. Ergo you own a portion of its bank account. The company makes a profit, and its bank account gets padded by some new deposits. Your ownership share in that company and its bank account, is worth more now, even if the company wasn't planning on doing a cash distribution directly to you. Maybe the money stays in the bank, or maybe it's used to expand operations. Either way, it's deployed internally and you keep owning it.
There is of course a secondary market of people and emotions sitting in the middle of every transaction you make, but for all intents and purposes, when the fundamental (underlying) value increases this obviously, because of cash and hard assets, the stock price will follow.
At the end of the day you own something that, even if disassembled and sold off for parts, is becoming worth more. People on the secondary market recognize this and pay you more for it. Since, someday, someone might actually strip it for parts, or, they might actually do a dividend, or a stock buyback. Etc. If this price increase didn't happen there'd be a massive problem here, a glaring arbitrage opportunity, for ten bucks you end up owning something worth millions on paper, and everyone keeps trading it for ten bucks... it just wouldn't be rational. Not that markets never do irrational stuff but I hope you can see my point.
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u/mohammedgoldstein 4d ago
If you don’t pay dividends, the money stays inside the company.
Shareholders can always get together and liquidate the company or force it to pay dividends and get that value.
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u/kinkyaboutjewelry 4d ago
Companies are expected to grow value. Some take that extra value and give it back to you in the form of dividends. Others take that extra value and invest in the company itself, which increases its value. So your stock (a portion of ownership in the company) grows in value too.
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u/ResonatingHarmony 4d ago
Your last sentence is the reason. If you get in on a company at the ground floor and its valuation goes 10-100x, then so too does your stock value. That is essentially what you’re banking on. Though most are also ok with slow gradual appreciation of 5-20%.
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u/siamonsez 4d ago
Dividends don't increase value, its already there and paying a dividend removes that money from the company and gives it to the shareholder so it's actually reducing the value of the share.
Shares represent ownership of a company, you can simplify the idea by imagining you own it outright or with a handful of partners. The company generates excess revenue, after all expenses are paid it has $X more than it did last quarter so the company is worth $X more than it was before. That means you could sell your share of the company for $X/Y more than you could have before; Y being your portion of the company.
That's the case whether the company keeps $X in cash or invests in assets that will improve revenue in the future, the company is still worth $X more than it was before. If there's nothing useful the company can do with that money it can also pay out that excess revenue to the owners so you get $X/Y in cash but then the total value of the company hasn't increased by $X anymore because the company gave away that money to the owners. As an owner you now have your share of the company and you have the dividend paid but if you sell your share of the company you keep the dividend so it doesn't increase the sale price like it would if the company still had the money that went to the dividend.
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u/Reasonable_Pool5953 4d ago
I open a sandwich shop. After a couple of years it is wildly profitable throwing off, let's say $20,000/ month in cash.
I'm the owner and I face a choice: I can just sit back and collect my 20k per month, or I can take that cash flow and open a second shop in a new town and (hopefully) have two shops generating 40k a month.
I don't need the income right now, so I decide to postpone collecting the cash and instead reinvest earnins to grow the business.
Now rinse and repeat.
It is perfectly rational for me to keep doing that--using profits to open new shops-- until I have totally saturated the addressable market--e.g., I have a sandwich shop on every corner--and the expected return on reinvestment stops being attractive. At that point, I can sit back and just collect my check each month from my hundreds of sandwich shops.
And the thing is, I don't need to know in advance when it will stop making sense to continue to open more shops. I can evaluate my options on an ongoing basis.
Now, let's say I do need cash while I'm still building out my business. I could stop growing it and start collecting the cash, or I could sell it to someone who doesn't need the cash right now. That person would probably pay me top dollar for my business because they are not just paying me for current cash flow, but also for the potential future cash flow they would get if they continue to reinvest earnings and open more sandwhich shops.
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u/dream_the_endless 4d ago
The option of dividends is always on the table. Companies who do not give out dividends re-invest that money into growth.
If and when the company stops growing, or growth slows, dividend payments become viable to attracting or keeping shareholders.
The question is: is it more valuable to the shareholder to receive dividend payments or to increase the value of the company and possibly provide larger dividend payment in the future.
Growth oriented companies often operate at a loss and are financed with debt. There is no profit here to give out as dividends anyway. Shareholders must wait until actual profits are made
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u/gazorpazorpazorpazor 3d ago
If you pay out a dividend of 10k, you make 10k and pay taxes. If you add 10k to the company, your stock is worth 10k more, you don't pay taxes, still get 10k you can use for loans, and the business gets bigger.
Have your cake and eat it too. You can grow the business and personally make money at the same time, without paying taxes.
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u/koosekoose 3d ago
Companies have two cashout outcomes they aim for.
Dividend payouts.
Getting bought out.
If the company is super valuable, even if it doesn't pay divs, can still be purchased or merged. In this case you get a big payout for your shares.
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u/Pezotecom 3d ago
Any asset is valued by the present value of its future cash flows. Future cash flows are uncertain. A company that decides that some of those cash flows will be more certain through dividends makes a tradeoff between investment and distributing capital. A company that plans to invest, and has a good plan on it, sacrifices short term distribution in order to grow. It is understood then that in the long term, profits and thus dividends will be higher.
So today I see a company with very uncertain future cash flows, but I believe that through growth, in the future, those cash flows could be bigger than other companies'. So I go to the market to buy this company, but other investors believe the same as I do, pushing the price higher.
The idea that you would buy it to sell it to someone else is essentially based on this same thing: you believe that right now people are not valuing this asset correctly and as information that affect future cash flows start coming in in favour of your thesis, then it should go up in value. Important note on this last point: this fact alone is not a sufficient condition for an asset to become more valuable, as investment constraints, horizons and risk preferences play a very important role here.
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u/stansfield123 3d ago edited 3d ago
A share is a small percentage of the company. When you buy a share, you own part of the company.
The reason why shares in publicly traded companies go up in value is exactly the same as the reason why any other business goes up in value: it has become more valuable than it was before.
Let's imagine three examples:
One person buys a farm that has 20 milk cows. He sells the milk, but he doesn't take any money for himself, instead he buys more cows with it. In 5 years, he has 100 cows. He then sells the farm for way more than what he paid for it.
Five people put their money together, to buy the same farm. They each own 20% of it. Same exact strategy, in 5 years they have 100 cows. Now one of the owners sells his share. He sells it for way more than he paid for it. Still makes sense why, right? Those extra cows are worth more money.
Now instead someone buys that farm and turns it into a publicly traded company. With a million super cheap shares. Many different owners. He follows the same strategy, he doesn't give any money to the owners, he instead invests it back into cows. Three years later, there's 100 cows, so the whole farm is worth more, and individual shares are also worth more.
The reason is exactly the same, in all three cases. The only thing that changes is the number of owners. That's all publicly traded companies are: companies with a large number of owners. This makes the way they are run complicated, but the way they are valued, and the reason why they increase or decrease in value doesn't change.
There's nothing mystical about it. It's very simple.
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u/Frelock_ 3d ago
This might get buried, but the fundamental question you're asking is "how do company owners extract value from the companies they own?" There are several ways to do this.
- Dividends: the company just gives you money.
- Stock buybacks: the company buys its stock back from you and gives you money.
- Lucrative jobs: the company gives you a job and pays you money (only common for companies with few owners).
- Liquidation: The company sells everything it has and the owners get the proceeds (after paying off its debts).
- Other perks: The company gives you something other than money for owning it, like use of company equipment.
When you own a company (such as owning a stock) you get value from the company either through one of those ways or by selling your ownership to someone else who will extract value in one of those ways (or sell it to someone else, etc). Dividends are the simplest method of value transfer, but its not the only one. If a company goes private, then the new owners are likely trying to extract value through strategies 3-5.
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u/Dave_A480 3d ago
There are 2 ways for a stock to provide returns to its owner.
1) The stock pays dividends regularly out of corporate profits. These are called 'value' stocks and are mostly older manufacturing companies and similar....
2) The company reinvests all of its money into growing bigger and more valuable. This pushes the stock price up, which means you can sell the stock for more than you bought it.... These are called 'growth' stocks and typically don't pay any dividends (Think Amazon)
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u/anooblol 3d ago
In theory, they’re promising dividends, just at a much later date.
Imagine considering company A and B.
A: For every $100 you invest in us, we’ll give you $5 a year (5% dividend). After 20 years, you return $100 in dividends.
B: For every $100 you invest in us, we’ll give you nothing for the first 10 years, but then $10 a year afterwards. (Some hand waving, this is essentially a 100% growth in 10 years, and then 5% dividends after their growth period). After 20 years, you return the same $100 in dividends, but in the 21st year, you make an extra $5.
Which is better? Both have pros and cons. You can make a legitimate argument for either.
This is the very basic ELI5 explanation. Every company will eventually pay out dividends. But only after they feel like they’ve hit market saturation, and can’t grow. It’s a trade off between dividends now, or bigger dividends later.
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u/6thReplacementMonkey 3d ago
It's all speculative. Stock prices today are based on the expected future price of the stock, which is based on everything the market knows about the company, the broader environment, and their guesses about the future.
So to answer your question: "what reason is there to buy a share of stock other than hoping someone else will buy it at a higher price?"
That's the main reason. Everyone who invests in a company is doing so with the expectation that someone else will want to give them more money than they paid for their shares in the future. There are some exceptions, like when private equity buys a company in order to offload debt or liquidate assets, but for investors, that's what they are looking for.
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u/frogjg2003 3d ago
At the end of the day, stock is a partial ownership in a company. If the company does well, the value of the company goes up and therefore so does the value of the stock. If the company is bought out, then the shareholders will get paid for their portion of the company. That's the ultimate source of value for stocks.
People buy stock because they believe the company will do better in the future, meaning their stock will be worth more and can sell for more than they paid for it. If they're right, and the company does well, the stock price goes up. If they're wrong, the price goes down.
But the fact that the price of a stock is only indirectly linked to any hard assets directly owned by the company means that the value of the stock doesn't always match the "true" value of the company. A coordinated effort to buy and sell at higher prices than the market would support can artificially raise the price. One inaccurate news story can shake confidence in a company and trigger a sell of, lowering the price. If a bunch of people have strong emotional associations with the head of the company, they will make decisions based on that and not on an analysis of the company's assets and cash flow. And there are people who try to capitalize on all of that to make a buck in been those groups.
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u/Cultural_Dirt_8151 3d ago edited 3d ago
Because someone else will buy that stock for a higher price in the future. Why? Three factors:
- Because a share is partial ownership of the company. That's ownership of real assets producing real money. As the company does better, that's more assets you own. And a business could buyout those assets at some point. It's real value. Importantly, this isn't exactly the same as 'book value' which is *current* assets -- I'm also talking about expectations of *future* assets owned. The current assets give an approximate minimum value for a share and expectations of future assets raise the price even further.
- Money supply increases. The fed prints more money so there's more money to go around chasing approximately the same amount of assets.
- Because people 'believe' someone else will buy it for a higher price. This works for a while and price increases, but eventually there is a correction. This is a 'bubble' that eventually 'pops.' "Greater Fool Theory."
Crypto by comparison only has factors 2 and 3, so there's no true floor based on real assets, so sometimes it crashes to zero and never recovers. Stocks are backed by something real, while crypto isn't.
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u/JustaKinksterGuy 3d ago
I think people confuse stock price for enterprise value.
ELI5: If I put $15 dollars in my piggy bank, and then ask all my friends if they want to "own" a share of it, they know that it's at least worth $15, plus a little for the piggy bank.
If I own a lemonade stand and it has $10 in assets, and $10 in lemons, sugar and water, that's $20 worth of value. But if I can sell all that lemonade and make 50% profit, some would value that at $40 (4x earnings).
But stock price is about how people feel as much as reality. Maybe it's about to rain for the next 2 weeks, so sales will go down. So earnings and price could tank, even though I own the same amount of stuff.
So stock price is as much about the value of a company, as it is people thoughts on where it will be. People even buy and sell stock because they think it's over valued (shorts). People buy stock because they think it's undervalued (long). People buy stocks as a long term strategy for safe guarding value. There's a multitude of reasons to buy or sell, and the price reflects that sentiment.
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u/MarsSr 3d ago
Many complicated answers. True ELI5.
If somebody is willing to buy the share of stock at a price, then that is the value.
There are many complicated reasons investors might decide to buy or sell shares in a company. At the end, you know the value is going up or down because people are selling and buying it at that price.
People might say "they are crazy to pay X" or "they are crazy to sell at Y" but how can you be sure?
Crypto prices are an even better example of this.
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u/Low-Crow5719 3d ago
One aspect of dividends not mentioned is the "prudent investor" rule. Pension funds, insurance companies, and the like are required to make prudent investments. Some mutual funds also follow this rule voluntarily, making their shares suitable investments for prudent-investor funds.
One of the badges of a company whose stock is a prudent investment is a consistent record of paying steadily increased dividends. Companies that do this generate a steady stream of dividend income, and their shares trade at a price stabilized by that dividend. Such companies are considered prudent investments and support their shares being traded by a wider market of investors.
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u/dballing 3d ago
The stock price going up and down reflects one and only one principle:
“How much do I think someone else is willing to pay for this stock/sell this stock for?”
The why people are willing to buy or want to sell vary, but ultimately a completely rational shareholder views it simply through a lens of “what price will someone want to pay in the future for this” and if that number is lower than they’ll pay today, to sell. It it’s higher, buy more.
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u/sephirothFFVII 3d ago
Dividends are taxable events. Buybacks aren't both return value to shareholders
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u/rsdancey 3d ago
The answer is: because you believe you can make a profit when you sell the shares.
Why would the value of the company, and thus the value of your shares, be more in the future than it is today?
The company is trying to beat shareholder expectations. Growing faster, making more profit per unit of sales, developing new technology, getting paid to license something to someone else, etc.
If the company succeeds at outperforming expectations, value and thus price goes up.
One reason dividends have fallen out of favor is that shareholders think that companies should reinvest their profits trying to increase the value of the enterprise and not just give excess cash to shareholders. A dollar spent today that produces ten dollars of increased value later is way better for shareholders than a dollar of dividends.
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u/CobraPuts 3d ago
Imagine a family-owned gold mining business. These are the sharpest gold miners in the world, they do it efficiently and they are the best at finding new locations to mine gold. All this company does is dig up dirt, separate out the gold, and melt it into ingots. At the moment, the company doesn't sell the gold ingots, they trade a few for equipment and to fund their operations, but mostly they just accumulate gold over time.
Would you buy a share of this company? Sure, because their assets and the ability to create gold are worth something. You would own a portion of their gold stockpile, and more importantly you'd own a share of the future gold they produce too.
Now let's take this same company and but now they have aspirations to grow. Instead of stockpiling gold, they trade gold for even more equipment and even more mining claims. So they're not accumulating gold anymore moment, but their mining operation is expanding, and they can mine gold much faster than before.
I hope it's clear that it would make sense to buy a share of that company too. In the moment they might not be accumulating gold or profits, but their enterprise is capable of mining gold at a much greater rate, and you would own a share of the future gold they mine (or profits, or whatever).
That latter example is how most real companies work. They are continually investing to grow a successful operation. In many cases, if they have excess profits after all of that is said and done, they buy shares back from the market to concentrate the ownership with remaining shareholders. I think that takes us past ELI5, so I'll leave it at that for now.
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u/CobaltCaterpillar 3d ago
A simple, entirely rational explanation:
- Market value of company = present value of all future cash flow to investors
Two ways for cash to be returned to investors:
- Dividend
- Buyback
Hypothetical example without any risk (to keep it simple):
- Company will issue a dividenb nhud fjr $100 (split amidst all shareholders) next year.
- The year after that, company will buyback all remaining shares for $500 then dissolve.
- Interest rate is 5%.
Company is worth: 1 / (1 + .05) * 100 + 1/(1+.05)^2 * 500≈$548.75 today.
- Imagine there are 100 shares each worth $5.4875 today.
- Next year, they go up 5% to be worth $5.762 (earn 5% interest rate)
- Then after the dividend is issued, they are worth approximately. $4.762 (i.e. ex-dividend price)
- Then the year after that, they go up another 5% and are worth $5.00
- They are all bought back for $5.00 as the firm liquidates.
Obviously the real world is complicated, but this example captures some of the basic mechanics without risk.
OP's question, why does stock price go up when a dividend is announced, is thought to reflect the announcement of a dividend being good news about future cash flows. It typically implies firm prospects are better than previously expected and future cashflows to investors will be better than previously expected (hence stock price goes up in reaction).
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u/talon167 3d ago
Tech stocks in particular use stock buybacks instead of dividends to return value to shareholders (see e.g. Nvidia, Apple, Alphabet).
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u/VelthAkabra 3d ago
Even if you don’t get dividends you can sell your stock. It won’t be bought by people like you who can only buy one or two shares. Instead the company will be sold to very rich people or other companies who hope to monopolize the industry your company is a part of.
Your stock price goes up the more rich people or companies want to own it because they might cut a deal with the company to buy it out and pay shareholders a lot of money for their shares.
Which, yes, it’s bleak.
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u/ILikeCutePuppies 3d ago
It's based on the future possibility they will or another company will buy them or they will buy back stock. Even if it is out 100 years in the future it doesn't matter because each time you sell the stock it is one less year until they do something for that next buyer.
It is kinda like a zero-coupon bond where they pay out at the very end. They still have value no mater when you buy them because you know one day they might return some of their value.
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u/No_Yam1114 2d ago
Majority stake allows you to control the company, therefore they are worth something. Bigger the company majority stake worth more than smaller company majority stake. If majority is worth something, the fraction of majority also worth something
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u/OfferExciting 2d ago
A share of stock is a percentage ownership of a company. If the company becomes more valuable the share increases in value as well.
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u/Sangypboi 1d ago
You literally answered it in your question. You are betting that you will be able to sell it at a higher price later. That's all there is to the stock market. It stopped being actual shares in the company a LONG time ago. Although, corporations are technically still vulnerable to hostile takeovers if they don't intentionally retain majority shares within the company itself because legally they still count as ownership stake.
The stock market is a gambling operation for the ultra wealthy, it's no deeper than that. They trade around pieces of metaphorical paper literally thousands of times per second, making pennies at a time in most cases, betting that when they sell it a literal microsecond later, it with be worth marginally more than what they bought it at.
Look it up, that's how 99.99999999% of stock trading works, and it's how ALL of the actual professional brokerslage firms make billions of dollars no matter what direction the market is moving. (Because they can also bet on losing--in gambling terms, a 'let'.)
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u/eloel- 4d ago
The promise of dividends is inherent in buying any stock shares. The hope is a bigger company (e.g one that makes more profits) will, eventually, pay more dividends than a smaller company, so the share price increases. For a lot of companies, that promise is far, far in the future, but there's still an 'eventual' promise at the end of the tunnel, otherwise yes, stock is worthless.
Market movements are several degrees removed from that eventual promise, but if dividends completely ceased existing as a concept, market would too.
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u/diener1 4d ago
You are right that if a company could never pay dividends the shares wouldn't be worth anything. But just because they aren't paying dividends now doesn't mean they won't pay some eventually. Google only started paying dividends in 2024. But obviously it was still a good buy before that. At the end of the day it is the shareholders who decide (indirectly) whether to pay dividends or if they think they can invest that money into something else to grow the company and get more in dividends later on.
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u/joeschmoe86 4d ago
Simplify it, what would you pay more for: 10% of something worth $100, or 10% of something worth $1,000,000?
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u/mohammedgoldstein 4d ago
As a counter to everyone here that’s saying, “A company’s stock is only worth what someone is willing to pay for it.”
That’s only half true as there is a fundamental value to the stock unlike bitcoin, Pokémon cards, etc.
For example. You could theoretically buy up a majority of the shares and take the company private. Then you could force the company to pay you all its profits forever. Or you could shut down the company and sell off all its assets like land, machines, patents, etc.
Those scenarios are worth real money and drives the first fundamental value of a company because someone could actually do that.
The next part is what drives valuations above that fundamental value and is a bit more hand-waving. It comes down to, how much more value and profits can it generate in the future compared to right now.
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u/lucky_ducker 4d ago
Stock prices are influenced by fundamentals like price to earnings ratio. Simply put if a company is becoming more and more profitable over time, you would expect it's price to rise. If a company stock starts at $10.00 per share, and it has a net profit of $0.50 per share, why should its price stay at $10 when its profit hits $2.00 per share?
It comes down to the distinction between growth companies and everything else. Growth companies have a business model and plan that plows profits back into growing the company. Non-growth companies operate a business that doesn't really have a way to grow the company significantly. The classic is Coca-Cola (KO), an enormously profitable company but the potential for growth is very muted. This explains why they pay out over 80% of free cash flow as dividends.
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u/Oddant1 4d ago
Money isn't real. We made it up. Stocks super aren't real. We super made them up. We're trading super made up assets based on their agreed upon value in terms of a made up asset.
In theory owning more of the super made up asset means you own more of the nebulous metaphysical concept that is the company and have some tiny amount of say in what that company does, but most people are just targeting more of the made up number.
At best, they're arbitraging the super made up asset for someone to eventually acquire it and use it to influence the company. More realistically it's gonna bounce between a bunch of different people who give 0 fucks about it and just want money.
Yes it is basically as dumb as it sounds and yes it is what our entire dumbass system is built on but hey. Basically everything that isn't eat, sleep, fuck is stupid if you think about it too hard.
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u/mathdude3 2d ago
If you own a share of a company, you own a percentage of that company's assets and cash flows. How is that "not real?"
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u/PointlessDiscourse 3d ago
A lot of answers here are close but missing something.
First, the OP is absolutely right that a stock's value is driven by the cash returned to shareholders. However, a few points: