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 a seasoned financial analyst with a wealth of experience in stock valuation and investment strategies, I've delved deeply into the nuances of assessing stock value, particularly in the absence of dividends. My expertise is underscored by a track record of successful investment analyses and a comprehensive understanding of the intricacies involved in evaluating companies from various sectors.
Let's break down the key concepts discussed in the article:
1. Price-to-Earnings Ratio (P/E Ratio):
The P/E ratio is a fundamental metric for valuing stocks, applicable even when dividends are not present. This ratio is calculated by dividing the market price per share by the earnings per share (EPS). A company with high earnings and a low stock price will yield a low P/E ratio, suggesting it may be undervalued. Value investors often consider stocks with low P/E ratios as potential opportunities, as they indicate the potential for future dividend payouts or stock appreciation.
2. Earnings Growth:
Growth investors prioritize metrics like year-over-year (YOY) earnings growth. The trajectory of a company's earnings over time is crucial for these investors. High and consistent earnings growth signals strength, whereas declining earnings might indicate underlying issues. In the absence of dividends, investors may still find value in a stock if the company is reinvesting its earnings for business growth, creating potential for future gains.
3. Book Value:
Book value serves as a valuable metric for companies with no earnings and no dividend payouts. By summing up a company's assets and liabilities, investors can calculate the book value. Stocks priced below book value are often considered attractive, as they may represent potential takeover targets or opportunities for substantial returns. The historical success of well-established companies, which have bounced back after falling below book value, is exemplified by figures such as Warren Buffett, who historically emphasized the significance of book value in investment decisions.
4. Reasons to Buy Stocks Without Dividends:
The article highlights various reasons to invest in stocks without dividends. In the past, growth companies were commonly associated with non-dividend-paying stocks, reflecting their focus on expansion rather than immediate returns to shareholders. In today's market, companies may opt not to pay dividends, reinvesting earnings in the anticipation that stock price appreciation will yield greater returns. Smaller companies, in particular, may adopt this strategy, and even large caps may forego dividends in favor of reinvestment strategies or share buybacks.
In summary, stocks without dividends can be valuable investments if they exhibit low P/E ratios, strong earnings growth, or are priced below book value. The key is to carefully evaluate a company's financial health, growth prospects, and strategic decisions to make informed investment decisions in the absence of dividend payments.
