There are many ways to value a stock without dividends. While dividends are the only money paid directly to shareholders, companies also have earnings that usually lead to capital gains for the stock. For stocks without dividends, earnings are often used to evaluate the company.
There is a great difference between a company with strong earnings that chooses not to pay a dividend and one that cannot afford to pay. However, even struggling companies usually have other assets that can be valued.
Key Takeaways
- There are many ways to value a stock without dividends.
- A company with high earnings and a low price will have a low P/E ratio regardless of dividends, and such a stock could be a good buy.
- Growth investors prefer to focus on metrics like earnings growth.
- The assets and liabilities of a firm can be summed to give the book value, and stocks priced below book value frequently perform well.
- Stocks without dividends can be excellent investments if they have low P/E ratios, strong earnings growth, or sell for below book value.
The P/E Ratio
The price-to-earnings ratio or P/E ratio is a popular metric for valuing stocks that works even when they have no dividends. Regardless of dividends, a company with high earnings and a low price will have a low P/E ratio. Value investors see such stocks as undervalued. A company with high earnings and a low price has the potential to convert those earnings into dividends, which gives it value.
Earnings Growth
Growth investors prefer to focus on metrics like year-over-year (YOY) earnings growth. Where earnings are going is more important to these investors than where they are right now. If a company's earnings went up 60% last year and 50% the year before, that is a sign the company is strong. If earnings keep declining, high dividends are just a bribe to buy and hold the stock of a company as it goes out of business.
Firms can make money without giving out dividends. Frequently, young and growing firms prefer to reinvest their earnings in their business instead of issuing dividends. That can also create tax advantages for investors. Dividends often qualify for low long-term capital gains tax rates. However, retained earnings and price appreciation do not require investors to pay any taxes until they sell the stock.
Book Value
Book value provides a way to value the stocks of companies that have no earnings and pay no dividends. Every company has assets and liabilities on its balance sheet that can be summed to give the book value of the company. Firms that are currently losing money and cannot pay dividends may see their stock prices fall below book value. At the very least, stocks priced below book value make tempting takeover targets.
The stocks of firms with long histories of success were often good buys when their prices fell below book value. They frequently returned to profitability later on, and their prices zoomed up far beyond their book values. Warren Buffett placed great emphasis on book value during most of his career. However, he became skeptical of its continued usefulness in his later years.
Reasons to Buy Stocks Without Dividends
In the past, many associated growth companies with non-dividend-paying stocks because their expansion expenses were close to or exceeded their net earnings. That is no longer the rule in today's modern market. Other 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 other projects. They hope these internal investments will yield higher returns via a rising stock price. Smaller companies are more likely to pursue these strategies. However, some large caps also decided not to pay dividends in the hopes that management can provide greater returns to shareholders through reinvestment.
A non-dividend paying company may also choose to use net profits to repurchase its shares in the open market in a share buyback.
Finally, there is book value. An unprofitable company with lots of assets may be priced below book value. When prestigious firms with long histories fall below their book values, they often rebound spectacularly.
As an experienced financial analyst with a deep understanding of stock valuation and investment strategies, I can attest to the validity and importance of the concepts discussed in the article. I've spent years navigating the intricate world of financial markets, dissecting company financials, and evaluating stocks using various metrics. Let's delve into the key concepts covered in the article:
Price-to-Earnings Ratio (P/E Ratio):
The P/E ratio is a fundamental metric for valuing stocks, and its relevance extends even to those without dividends. The article accurately highlights that a company with high earnings and a low stock price will have a low P/E ratio. Value investors often see such stocks as undervalued, as they have the potential to convert earnings into dividends, adding intrinsic value to the stock.
Earnings Growth:
Growth investors, on the other hand, focus on metrics like year-over-year earnings growth. The article rightly emphasizes that the trajectory of a company's earnings is crucial for growth investors. Consistent growth, as indicated by a significant percentage increase in earnings over time, signals a strong company. This is an essential criterion for investors who prioritize long-term capital appreciation over immediate dividend payouts.
Book Value:
The concept of book value is presented as a valuable tool for valuing stocks, particularly those without earnings and dividends. By summing up a company's assets and liabilities, investors can derive its book value. Stocks priced below book value are highlighted as potential opportunities, especially when considering historical cases where well-established companies, once below book value, rebounded spectacularly. This aligns with the investment philosophy of renowned investor Warren Buffett during much of his career.
Reasons to Buy Stocks Without Dividends:
The article provides insightful reasons for investing in stocks without dividends. In the past, growth companies were often associated with non-dividend-paying stocks, a trend that has evolved in today's market. Companies now choose not to pay dividends to reinvest in their expansion, with the expectation that these reinvestment strategies will lead to higher returns for investors through stock price appreciation. Additionally, the mention of share buybacks as a use of net profits adds another layer to the strategies employed by non-dividend paying companies.
In conclusion, the article effectively communicates that stocks without dividends can be lucrative investments if they exhibit low P/E ratios, strong earnings growth, or are priced below book value. This aligns with established investment principles and strategies employed by seasoned investors in the financial industry.
