Facebook pays no dividend and Starbucks does. Does this mean that Facebook is sh
ID: 2702308 • Letter: F
Question
Facebook pays no dividend and Starbucks does. Does this mean that Facebook is short of cash or fears running out of cash while the management of Starbucks is more confident?
Why doesn%u2019t Facebook pay a dividend? Why doesn%u2019t Google pay a dividend? Can FB and Google afford to pay a dividend? Why don%u2019%uFFFD t owners demand a dividend from these companies?
Why would anyone buy shares in a firm that pays no dividends and has no plans to pay a dividend in the %u201Cnear future%u201D when they can buy shares in a company like INTEL that does pay a dividend and in fact has a high dividend yield?
Please make it as in depth as you can
Explanation / Answer
Dividends are corporate earnings that companies pass on to their shareholders. There are a number of reasons why a corporation might choose to pass some of its earnings on as dividends. There are also a number of reasons why it might prefer to reinvest all of its earnings back into the company.
A company like facebook that is still growing rapidly usually won't pay dividends, because it wants to invest as much as possible into further growth. Even a mature firm that believes it will do a better job of increasing its value (and therefore a better job of increasing its share price) by reinvesting its earnings will choose not to pay dividends. Companies that don't pay dividends might use the money to start a new project, acquire new assets, repurchase some of their shares or even buy out another company.
Also, the choice to not pay dividends may be more beneficial to investors from a tax perspective. Dividends are taxable to investors as ordinary income, which means an investor's tax rate on dividends is the same as his marginal tax rate. Marginal tax rates can be as high as 35% (as of 2012). The capital gains on the sale of appreciated stock can have a lower, long-term capital gains tax rate (typically 15% as of 2012) if the investor has held the stock for more than a year.
Firms that choose to reinvest all of their earnings, instead of issuing dividends, may also be thinking about the high potential expense of issuing new stock. To avoid the risk of needing to raise money this way, they choose to keep all of their earnings.
However, for a mature company like starbucks that doesn't need to reinvest as much in itself, and that has stable earnings, there are several reasons why issuing dividends can be a good idea. Many investors like the steady income associated with dividends, so they will be more likely to buy that company's stock. Investors also see a dividend payment as a sign of a company's strength and a sign that management has positive expectations for future earnings, which again makes the stock more attractive. A greater demand for a company's stock will increase its price.
A company may also choose not to pay dividends because the decision to start paying dividends or to increase an existing dividend payment is a serious one. A company that eliminates or reduces its existing dividend payment may be viewed unfavorably and its stock price may decrease.
Facebook may not pay a dividend if its directors believe that it's better to put the business's profits to work making the business itself more valuable. Warren Buffett's Berkshire Hathaway is a famous example of this; the company has grown through acquiring other good businesses, mostly in the US and Canada, many of which themselves pay dividends. If Buffet and his partner Charlie Munger ever felt that the best use of the company's profits were to return it to shareholders, Berkshire Hathaway would pay a dividend.
An established business with a dominance in the market and few opportunities to grow doesn't always have this luxury. In that case, the value of the stock depends on being able to pay a good and steady dividend. In other cases, the value of the stock depends on the company growing larger and making steadily more money. These growth stocks often do not pay dividends.
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