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Comment by cpeterso | Hacker News Reader

At a very basic level, I don't understand the stock market. A private company can raise capital through an IPO. But what are the investors really buying? The company might pay a dividend, but many don't. Investors can purportedly elect the board of directors, but in reality, few investors have any influence. So what (liquid) investment have the shareholders bought that is actually appreciating in value?

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The fact that most companies don't pay a dividend is really a tax hack. Before 1980, most companies did pay dividends.

When the tax rate on capital gains (now 20%) dropped far below that for dividends (30%+), companies realized they could spend the same amount of money buying back shares. This should drive up the share price by the same amount as an issued dividend (do the math). The difference is that investors can sell shares and only pay 20% instead of 30%+.

"Qualified dividends" are taxed as long-term capital gains, or not taxed at all if you're in the 15% or 10% bracket: http://en.wikipedia.org/wiki/Qualified_dividend. Although apparently the reduced rates will expire in 2012 unless they're extended again.

Not to mentioned that this only started in 2003, which was of course too late.

If a company is not paying dividends, it is (hopefully) reinvesting in itself and growing. Theoretically, all growing companies will reach one of the following points:

1) It will stop growing, and begin paying out dividends

2) It will be acquired

3) It will fold

So, ownership of stocks that do not pay dividends is speculative- eventually, it will either fold or net you money. This is not liquid, of course- stock trading is the liquidation of this speculation, if that makes sense, in the same way that you hold a bond in anticipation of future returns, but you could sell the bond for more immediate gains.

(As I understand it, the reason why a growing company will, in theory, eventually pay out dividends rather than just keeping wads of cash is because once the return of reinvestment tapers off, major shareholders will band together to force the company to pay out dividends)

You're right to be suspicious of the whole system. As a stockholder you are basically last in line to get compensation from a bankruptcy proceeding. The bondholders will get paid well before you will.

Investing without a dividend is just speculation.

Tell that to people who have been buying Apple stock. Disclaimer - Ive never owned Apple stock at any point in time.

The simplified version:

Stock gives you a share of current and future profits (via dividends) as well as a share of the liquidation value of the company. If a company continues to acquire assets, this increases its liquidation value; some companies do this rather than paying dividends because it's more tax-efficient for investors.

One of Warren Buffett's investment strategies is to look for companies that are stable but whose stock is trading at below liquidation value.

Strictly speaking, investors buy a part of a company, buy contributing to it's equity. If company is expected to grow without putting on too much debt, its equity will grow too and a fixed part of it (if we forget about dilution for a moment) is expected to appreciate as well.

Growth

To be more precise, stock price growth. I think in most cases it is better to do dividends and move away from stock price based compensation.

If you want that then buy established companies.

Otherwise, as an investor it's better to keep money within the company to fuel its growth so it can pay better dividends in the future.

This is similar to how startup founders often don't draw a salary just to have more money to invest in the growth of their company.

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