Economic subjects | Investments, Stock exchange » What is the incentive to buy a stock without dividends

Source: http://www.doksinet What is the incentive to buy a stock without dividends? The asker of the question continues: "I mean, if there is no income to the shareholders, why does the company go public? I understand that some small-cap stocks may have to use all their earnings or net income in order to grow, but how about large caps (like Microsoft) who do not typically pay dividends to their investors? Why do investors buy the stock if they know they wont get any dividends?" This is an excellent question based on a common misunderstanding of the stock market. The answer can be summed up with two main points: 1) A stocks return is its dividends plus capital gain. 2) Buying a stock means you are part owner of the company. Many investors have the misconception that dividends are the only way to make money with stocks. While dividends are the only direct income (money paid out), the total return of holding a stock is the dividend plus the capital gain of the stock price.

Dividend-paying stocks consist mainly of well-established and mature firms (i.e blue-chip stocks). The reason is that these companies have grown to a point where they are now leaders in their industries, characterized by having slow but very steady earnings growth. These established companies are mainly concerned with maintaining their position by increasing efficiency and keeping shareholders happy with dividend payments. Investors buy the shares because the companies are usually large, stable and reputable and, thus, low-risk investments. Furthermore, these companies tend to maintain dividend payments, providing a sense of safety to investors looking to diversify into the equity markets without the high risks of investing in growth companies. In the past, the market considered non-dividend-paying stocks to be typically growth companies since expenses from growth initiatives were close to or exceeded their net earnings. This is no longer the rule since a transformation has occurred in

todays modern market: firms have decided not to pay dividends under the principle that their reinvestment strategies will, through stock price appreciation, lead to greater returns for the investor. Thus, investors who buy stocks that do not pay dividends prefer to see these companies reinvest their earnings to fund expansion and other projects which they hope will yield greater returns via rising stock price. Although these are generally small- to medium-cap companies, certain large caps have also decided not to pay dividends in the hopes that management can provide greater returns to shareholders through reinvestment. Second, its important to remember that when you buy stock you become part owner of the company. As such you have a claim to part of all assets and future earnings Too many investors forget that they are buying not just into some financial instrument but into a company. Therefore, you must ask yourself: what is the best use of earnings? Can I reinvest my dividend to

yield a higher return than if the company reinvested its earnings? The answer to this question will vary for individual investors and from company to company. Finally, its worth mentioning that many people blame taxes for the shift away from dividends. In North America dividends are double-taxed, meaning corporations pay dividends from their after-tax profits, and then shareholders must pay tax again on the income received from dividends. Because of this tax treatment many investors have chosen not to buy dividend-paying stocks. In turn, many companies, to help their position in the market, have stopped paying dividends. Microsoft is a great example Despite the fact it can afford to pay dividends, it chooses to buyback shares and reinvest it. Alternately, a large cap may pay a non-recurring special dividend, as Microsoft did in 2004