Why tech companies never pay out their earnings as dividends
fiveyearstoolate.wordpress.com
fiveyearstoolate.wordpress.com
Also, in terms of returning retained earnings to investors, there is no difference between a company paying dividends and a company repurchasing shares (assuming the shares are fairly valued). Happily, though, when a company repurchases shares, it doesn’t affect the strike price of stock options. Thus, tech firms don’t pay dividends and they repurchase shares instead. So in addition to the "dividend yield", we also need to add in all the capital that Microsoft spent on share repurchases, which was $47.7B in the fiscal year ending in June 2009 (http://www.microsoft.com/msft/reports/ar09/10k_fr_fin.html). That ain’t nothing.
As an aside, Microsoft started paying dividends only after switching from using employee stock options to using restricted stock (the value of which isn’t affected by dividend payments).
These points aside, the author has a good point, which is that more tech firms should do more to return retained earnings to shareholders (whether via share repurchases or dividends).
To me this looks more like a device used by managements to justify their practice of share repurchase. The options should be repriced not when dividends are paid but rather when stock repurchase is done. Like you mention, stock repurchase never affects the strike price of options. There is a very informative comment on stock repurchases by Warren Buffet in this 2005 annual report - http://www.berkshirehathaway.com/2005arn/2005ar.pdf
For an extreme example, imagine a hypothetical company with 1 billion shares outstanding and $1B in the bank and no other business than earning interest on its cash. With $1B in the bank, it should be valued at $1/share plus some share of expected future interest payments. Pay out a $1/share dividend, and the company is now worth $0.
As twitter has shown, valuation does not need to correlate to any traditional financial metric whatsoever. Twitter is worth 1 Bn becomes someone decided to pay for a stake at that valuation. No other reason.
Since everyone expects it to happen it generally does.
The fact is, there is nothing predictable in the stock market.
edit: as BobbyH points out, my point about shorting is mistaken but that does not change the key point about unpredictability of the markets vis a vis declaring a dividend.
I think that while there is a lot that is unpredictable about the stock market, you can be fairly sure that on a dividend's effective date, the share price will fall by roughly the amount of the dividend. It won't be exact due to all the other factors which would affect a stock's price on any day, but it will be roughly correct.
That's why investors can't make an infinite amount of money by shorting stocks right prior to the dividend date...
You guys really get tripped up in irrelevant minutiae...
Your hypothetical example though is a very useful way of understanding these things. Infact it just helped me understand clearly why companies should keep as little cash as possible - unless they can generate returns better than atleast govt bonds.
If not paid as a dividend, where else would that profit go but to cash in the bank at time T+1? (Technically, it's free cash flow that goes to cash in the bank, but the difference isn't meaningful here.)
Companies are allowed to keep their income so long as it is necessary for their business. You might think that a mom and pop store would be allowed to keep millions in cash, but since that kind of money isnt necessary for the operation of the business the excess gets taxed at 80%. (My info is old so the exact percentage may be out of date.) Large tech companies like Microsoft and Intel pay nominal dividends to keep the Federales at by, not out of generosity to their stockholders.
He moves on to say that these tech giants usually end up dying anyway, so he is suggesting they "die with dignity" or at least realize when they should stop growing into new markets tangential to their core competency.
In practice, no.
Most companies are run by people who are utterly bad at allocating capital. They will buy stock back when it is overvalued, when it is trading towards its high because they feel on top of the world and unstoppable. They are almost always making a grave mistake.
Share buybacks need to be used like Henry Singleton at Teledyne:
You buy back stock when it is trading towards its lows and likely undervalued.
You issue stock and use it as currency for acquisitions when it is trading near highs so that you take advantage of its overvalued status in the market place.
http://en.wikipedia.org/wiki/Henry_Earl_Singleton
Singleton showed how to properly allocate capital in tech and do it in a way that enriches everyone. That's why most people today look to what he did at Teledyne as models for best practices in capital allocation.
If you can know when shares are low or high, there are lots of ways of using that information. The problem is knowing.
It's the disagreement on what something's worth that makes the market.
http://www.google.com/finance?q=ibm
http://www.google.com/finance?q=microsoft
http://www.google.com/finance?q=sun
http://www.google.com/finance?q=oracle
etc. etc. etc.
And their dividend payouts are about on par with my non-tech holdings also.
I'm not sure if this is true if you looked at the tech industry as a whole. I think it is, but my view is biased from almost purely following GOOG, AAPL, MSFT, etc.
But if it is true, it would be a good explanation as to why Warren Buffett does not invest in tech companies.
"What would I do?" Mr. Dell said to an audience of several thousand information technology managers. "I'd shut it down and give the money back to the shareholders."
The rest, is as well all know, history - Apple became worth more than Dell in 2006, and today, is worth almost six times as much as Dell.
I'm pretty certain Apple investors are happy that Apple didn't start issuing dividends and run the company on its (by then dying) Mac OS 8.x, but decided to completely reinvent itself on NeXT OS (aka OS X).
An anecdote, but a useful one.
Apple is a case of one success versus a universe of failures
But that would definitely apply to 2010 Apple & Microsoft : should they continue to look for growth at all cost, or start paying big (bigger) dividends to shareholders? I lean toward investing... continue to try to change the world, please. Even if lately Microsoft seems to be bad at it (but are they really?), trying to follow the leaders instead of implementing a vision, it doesn't mean it's too late...
This belief I guess comes out in part due to the meteoric profit growth that successful tech companies witness which leads to hubris in the management. The other reason for this belief is the shareholders themselves who let management invest profits in any project they want in the hope of ever increasing profits and stock price.
About microsoft's dividends, one thing the article misses is that msft's payout is very high but most of it is via stock repurchases. The reality is that managements of all companies - tech or otherwise - concentrate on their own interests. That is why you see companies spending so much on stock repurchases rather than pure dividends. In theory it reduces the number of shares - but in practice it is a device to prop up the stock price so stock options or stock price linked benefits for employees and management are profitable. Microsoft spends disproportionately higher on stock repurchases compared to dividends. If they paid all that money as dividends, it would be a very decent dividend paying company.
I may be wrong though, I'm just starting to learn more about corporate finance.
"Most"? The press accounts around Google's IPO said that voting preferences were somewhat rare. They mentioned some newspaper companies and Ford.
Do MS, Apple, or Cisco have voting preferences?
1. the stock price should accurately reflect the earnings of the firm. When a dividend is announced, the price of the stock decreases by the amount of the dividend. If you want some of those earnings, then sell a share. There's no need for the company to issue a dividend. This is a common misconception most people have.
2. You're taxed on the dividend payments (exceptions tax deferred retirement accounts). This is annoying, especially if you don't want them now and would rather have them just reinvested. Ignoring taxes, the value to the shareholder is the same regardless of whether dividends are paid or not.
My professors in finance all go on long rants against paying dividends, and it really does seem that they're antiquated. Most newer firms just don't pay dividends, and tech companies just happen to be newer firms usually. It's not necessary a property of just tech companies.
I don't believe that. The purpose of a company is to make money for its owners. Dividends are payments to the owners of the money the company makes.
As far as capital gains goes, that is just a side-effect (albeit, a potentially lucrative one).
Put another way: Company X's stock is $100/share. They issue a 50 cent dividend. The stock price will go down to $99.50/share upon announcement. The investors/owners still have $100 whether the dividend is issued or not, except the investors have to pay taxes on that 50 cent dividend now instead of having it re-invested.
This traditional view holds that companies are fundamentally different than barrels of oil, in that they can produce wealth and provide reasonable returns to their share-holders year after year and that you can take your 7% appreciation at the rate the economy grows (or at least used to).
Timing the market is certainly a valid (if highly risky) strategy, but it's only one view of investing. It's only in this strategy which dividends don't make sense.
That statement is patently incorrect, in theory and in practice.
PRACTICE
The share price of companies that announce dividends every quarter has little immediate correlation to the dividend announced. In the long term, companies that consistently raise dividends year over year actually increase in value. (These are affectionately referenced as "dividend darlings" and are a focus of some investment strategies.)
THEORY
The purpose of a company is to make money. You do this by spending capital to create a product. Once you sell that product, you regain back the capital you invested in earnings. The goal is to eventually make back more money in earnings than what you invested in capital.
If I buy a bar in my neighborhood for, say, $100k, I would expect to make money back on it. If I worked hard to build a clientele and earned something like $30k a year from my customers (a spectacular return, by the way), then the bar would be earning money. I could then afford to pay some of that out to the shareholders - in this case, just me.
What your notion of dividends seems to be is a cannibalization of the equity present in the company. If the company has no product of intrinsic value, then yes, your example might hold true. In the bar example, you would believe that the bar is worth only $100k (the price I paid) and that any money I pay out would be coming out of that $100k. This would be true only if I did not work to get customers and therefore did not make any money over the year.
SUMMARY
For companies that provide value in the form of goods and services, the money you get out of it will be more than the money you put in. This frequently, and oftentimes should, take the form of dividend payments.
ALTERNATIVE
Having said all that, there are very legitimate reasons why tech companies do not pay out dividends, namely that they reinvest the profits in research and development to produce new and better products. I don't think anyone who bought Apple stock seven years ago is complaining about the lack.
Now that most companies refuse to wind down except in severe distress (you'll only get a sliver of the assets' market value) and don't pay dividends, the connection between profits and the investors is severed. The only reason share prices are vaguely correlated to profits is that investors are speculating on each others' faith in a mystical connection between profits and share prices. It's like a baseball card with the name of your favorite sales team on it.
The economy would function better if it rewarded buy-and-hold investors for good long-term governance of companies. Instead we tax dividends harder than selling out, make the share price all-important, and reward exponential over-expansion (that's largely where profits go, it's psychologically impressive even if it's less profitable) and market-timing speculators' games.