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Common Stocks and Uncommon Profits

Dividends

A company which is not paying dividends is not necessarily a bad company. It might signify that the company wants to set up a new plant, invest in a better project, etc. This will make a company generate better profits in the long run. A stockholder will not benefit from retained earnings if the company is capable of using the retained earnings properly.

 

Another way by which a stockholder will not benefit when a company retains its profits is when the management of that company will pay higher salaries to themselves. Our accounting methods don’t show a way by which we can identify what the retained earnings are used for. For example, a company may buy expensive paintings without any reason, but there’s no way to know that.

 

A person who needs current income should invest in a dividend-paying stock. A long-term investor shouldn’t be bothered about dividends. We as investors get carried away by seeing huge dividends. But we miss the fact that a company forgoes other opportunities to reinvest its earnings to distribute it as dividends. A growing company will most likely not pay dividends at all for several years before its price appreciation stops.

 

At the end of the day, the important factor is where the capital can be employed in order to provide the highest value to the shareholder. Earnings that are retained could be used for new plants, major cost saving initiatives over the long run, or product development. Whether or not the highest value for the shareholder would be achieved through dividends or through the management retaining earnings is therefore an issue that must be examined from time to time.

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Units 8/18