Why aren't non-dividend stocks ponzi assets?

Question

I'm trying to see why a non-dividend stock isn't subject to the Greater Fool Theory

There's no intrinsic connection between the stock price and actual company profits without dividends.

So my question is... suppose a stock price were to continuously drop despite high company performance (profits)... Is there something the shareholders can do to get some share of the profits?

Only thing I see is voting for the board of directors in the hopes new members will put in a dividend plan? Is there anything else?

Answer 1

I started to close this as a duplicate of If a stock doesn't pay dividends, then why is the stock worth anything?, but then realized that it is a slightly different question:

suppose a stock price were to continuously drop despite high company performance (profits)... Is there something the shareholders can do to get some share of the profits?

As a shareholder, you aren't entitled to a share of the profits directly, but a share of the net assets of the company. In most cases, profits increase the net assets (or potential for future net assets by reinvesting them in the company), thus increasing the stock price.

If a company with high profits is dropping in stock price (equity value) then it's wasting cash somewhere else, perhaps by buying new assets (which isn't reflected in "profits") that the market thinks they overpaid for. Or the market thinks those profits are going to be short-lived.

How can I as a shareholder access the company's assets?

You can't directly. A share of stock is a claim on that portion of the company's assets (after debts have been paid). It's the claim that has value and your shares should reflect the market value of those assets (plus, possibly, future growth), so if the company is public (and the stock is liquid), then you can sell them to another investor for a fair value.

Or, if the company were to be bought out, merged, or otherwise liquidated, you would receive a proportional share of the company. Maybe in cash, or maybe in stock of equivalent value in another company in the case of an acquisition or merger.

Say someone buys 51% of the shares. Now he wants to liquidate the assets. Does he have the rights to do that? How would he go about doing that?

Conceptually, yes, but in reality it's not quite that simple. They would have control of the board of directors, which would be able to tell management what to do (or find a buyer on their own), enact any policy they want, or something along those lines. But it's that conceptual possibility that keeps the stock price from being "arbitrary". However, there are laws that protect the interest of minority shareholders from a single shareholder (even with 51% interest) so any actions to "liquidate the assets" must be in the best interest of all shareholders.

Answer 2

Ultimately, if you own the company, you can vote to shut down the company, sell everything it owns and give the money to the shareholders.

You can also vote for the company to start paying dividends.

Basically, the money in the company is not locked in the company, even if it's staying there for the time being. Eventually the shareholders will get some of that money; so the expectation of getting that money eventually is worth some money now. Even if the company doesn't actually give out any money for 20 years, you can buy the stock now and sell it in 1 year to another person who only has to wait 19 years to get their money; this can continue 19 more times until someone gets the company's money.

Answer 3

So my question is... suppose a stock price were to continuously drop despite high company performance (profits)... Is there something the shareholders can do to get some share of the profits?

This seems like a faulty premise. The stock price is based on the market's estimate of the company's future prospects. It's unlikely that a company that has high performance now will experience major downturn, and even more unlikely that investors will be able to predict this and factor it into the stock price.

Stock prices don't move by themselves, they're the result of investors actually buying and selling shares. Theoretically, their decisions about what price to buy/sell at are based on reliable information about the company's activity and prospects. Of course, information isn't always perfect and complete, and predicting the future reliably is impossible, which is why different investors may have different valuations of the same company, and this is what fuels the market. But generally the stock price is a reasonable representation of the company's value.

There can be exceptions. A company might be doing well in a market whose future prospects are dim. For instance, when cars took over from horses as the dominant form of transportation, investors could predict that the horse-drawn wagon industry would decline, and companies that didn't make the transition were in trouble.

There can also be anomalies like the GameStop short squeeze early this year, where a group of investors triggered a sudden run-up of the share price. This is unusual because the perpetrators of this also suffered losses as a result -- they were essentially sacrificing small losses by each individual to cause large hedge funds to lose millions of dollars.

All that said, I've often had a similar feeling to yours. It does seem like the stock market is just a big game. Yes, I can vote my shares, but the majority investors have almost total control, so my vote has little significance (Mark Zuckerberg personally owns a majority of Facebook stock, so no one can outvote him). Non-dividend shares of stock don't produce any intrinsic returns unless the company liquidates and distributes assets to investors.

But the market works because investors want it to work. It's not a Ponzi scheme because there is some underlying valuation involved. The companies we invest in make things and/or perform services. While it sometimes feels like gambling, it's not like a casino because outcomes aren't random: well-run companies in a healthy industry generally do well, poorly run companies and companies in a declining industry don't. And if you do your due diligence, you can usually tell which are which. If you want to compare it with games, it's more like sports betting than roulette -- you can look at the records of all the teams when deciding which one to place your bet on.

There's a reason why there are successful investors and fund managers like Warren Buffett and Peter Lynch -- knowledge and experience actually matter when deciding what to invest in.

Answer 4

This is a really common idea that I've seen lately. It's usually part of a rationalization about how owning stock in a company is no different than owning something that is only worth what someone will pay you for it e.g. Bitcoin.

There are lots of ways to debunk this but I think the easiest way to see why this isn't (normally) the case is to ignore large established companies for the moment and consider a new startup company. Imagine you and a friend create a company. We'll call it sharma.com. He's doing the work but you are putting up all the money. You agree to a 60-40 split. As part of setting up the company, you issue 1000 shares. You own 600 and your friend owns 400. sharma.com launches and starts making money. You take half the profits and issue dividends which means you are getting 30% of the net profits and your partner is getting 20%. Pretty straightforward, right?

Now, let's say sharma.com keeps growing and you and your partner decide to quit your day jobs. You become CEO and your partner is CTO which pay salaries that you can live on. You decide that you'd rather use the profits to grow the company and not issue dividends which (as majority stakeholder) is your right to choose to do.

Fast forward a few years. sharma.com is killing it. You've given shares to new partners to help grow your company. You are still the biggest shareholder at 10% and that is now worth far more than your 60% ever was. No dividends have been issued for a while. In fact, even if you wanted to, you couldn't make that happen on your own. You'd need at least another combined 41% of ownership to vote with you and all the other owners want to keep reinvesting. In fact, the majority wants to go public. You issue an IPO and it's a great success but it further dilutes your ownership. You now only own 5% and a huge number of people and institutions now are also owners.

Now it's a big company and still no dividends are being issued. Does it suddenly become a ponzi scheme? If you believe that, then you must also believe that it was a ponzi scheme back when you and your friend started the company. But that doesn't really make sense, does it? You created a company and it makes money and you are part owner of that company. What about the retail investor that owns 0.001% of the company? The only difference between their ownership and yours is scale.*

So the question comes back to: if no dividends are ever issued, isn't owning stock just a 'greater fool' negative-sum game where the only way you get something is to sell it to someone else for more than you paid? I would agree if a given company:

• never issued shares
• never was purchased or acquired

But the fact that a company doesn't issue shares now doesn't mean it never will. If a company means to grow, it's profits are the cheapest type of capital available to it. There are lots of companies that didn't issue dividends until they reached a point where attempts to reinvest are ineffective. Some companies end up wasting money attempting to grow when they should have issued dividends. A lot of companies never issue dividends because they are acquired by a larger company that does.

There's no one answer and this doesn't mean all stocks are good investments. The point here is that stock ownership literally means you own part of a going business. You have rights as an owner even if the fraction you own is miniscule. For example, back in the aughties when Michael Saylor defrauded investors in Microstrategy by signing off on accounting statements that said the company was profitable (it wasn't), he was forced to pay the stockholders as part of a settlement. Even owning part of something run by a con artist grants you some rights, legally. It's not like owning an entry on a ledger that points to a URI of a (pretty terrible) picture of a rock. There's a real business there and if the people running it are lying about what it does or how much money it makes etc. there are real-world consequences to that.

If suddenly no one thinks it's worth owning ledger entries that point to URIs of a poorly drawn rock (I know, crazy right, but hypothetically) then they will become worthless. Companies need to be real to issue stock. I can't just create a new ticker attached to nothing and put it on the NYSE like I could sell the words 'sword of awesomeness' as an NFT. It's not at all the same thing.

To be clear, this doesn't mean all companies are worth buying. You can invest in a company and see it crash and burn. Stockholders (i.e. owners) get paid last in a liquidation and there might not be anything left after the creditors come for their money.

I want to add another way to think about this but coming from another direction. Consider Amazon which doesn't pay dividends. Imagine some scenario where suddenly everyone decides it's true that because it doesn't issue a dividend (today) that it's just a ponzi scheme and the price of the stock plummets. In 2020, Amazon reported a net income of $21 billion and you can buy all of it because everyone (including Bezos) is selling their stock at fractions of a penny. In what universe would it not make sense to buy it? You could take control and give yourself gigantic dividend. That's not how ponzi schemes work. When they collapse, there's nothing to buy.

*Note: some companies such as Facebook sell non-voting shares on the market which is different from owning shares with voting rights.

Answer 5

Dividends and speculation aren't the only upsides to owning a stock.

• The company could decide to execute a stock buyback. This will increase demand for the stock you own and drive up the price.
• The company could be acquired, raising the stock price substantially.
• The company could decide to start paying dividend.
• The shareholder could vote to alter the leadership.

Remember that the price of an asset is not just based on its current value, but its presumed future value.

As a minor shareholder, you don't have much recourse to grab a piece of the pie as it were if the stock price is not going your way. Great companies go down and trash companies go up all the time, join the club. There's a reason people say the market is irrational. However the fact is that as a purely observational point, your hypothetical scenario of profits going up while the stock goes down is not common on a large scale.

The only way you can literally get a piece of the assets is if the company goes bankrupt. Bankrupt companies tend to have a lot of debt from having tried to stave off the bankruptcy in the preceding period, and creditors get first dibs. Then come the preferred shares, if there's anything left. Finally the lowly common stock holders gets to wet his beak, but at that point usually very little remains - a company that has such sizable assets that even the common stocks get their piece is in a strong financial position and has better options than declaring bankruptcy. In your hypothetical of a company with ever-increasing profits, there is no reason at all why it would become bankrupt.

Answer 6

No dividend

There are several points here. Let's take each one. First, an enterprise with zero dividends is priced as zero in a dividend discount model (DDM).

Let me repeat the last part: in a dividend discount model.

This is an "all models are wrong, some are useful" situation. There are several pricing models over there, and you need to choose one that is more appropriate for the task at hand. You don't pick DDM for a non dividend stock. You used the wrong model to reach the wrong conclusion.

Companies may have profit, Ponzi schemes only have losses. The "no dividend" part is not what differentiates them.

How to access the profits

The other question is if there is a way to access the profits of a company that the price is falling and pays no dividend. Well, there is. You could buy enough shares to gain control of the company and then determine to share the dividends, or even better, you could buy all the shares, and have the profits only to you.

There is no general way for a minority shareholder to force a company to pay a special dividend only for him.

Answer 7

There's no intrinsic connection between the stock price and actual company profits without dividends.

That is not true. If the stockholders are voting in Directors who don't give dividends, it can only be because the stockholders are made even better off by the absence of dividends than they would be if there were dividends. The company's profits as dividends sets the floor for the benefit to the stockholders and the stock price is directly connected to the benefit to the stockholders.

So this is completely false.

So my question is... suppose a stock price were to continuously drop despite high company performance (profits)... Is there something the shareholders can do to get some share of the profits?

They would likely vote in new Directors whose policies are more to their liking. If they don't think there's anything the company can do with its profits that is better for them than a dividend, then they will vote in Directors who will pay dividends.

If you have a stock where the voting arrangement is so screwed up that the company can't act in the interest of its stockholders, then you do have a problem. There are sometimes legal remedies for this, but it can make a stock worth much less than its performance would otherwise make you expect.

Answer 8

You own a share of a business.

The business might indeed be worthless, and trading on what amounts to a fraudulent or misleading description and greater fools buying it. Theranos, for example.

But if it's a growing company investing all the money it earns in expanding, there's something there with real and hopefully lasting value. Eventually, it will transition to a company that's no longer expanding fast, that will pay off its debts, and pay dividends or otherwise distribute income to shareholders. Or quite often, before then, a bigger company with deeper pockets makes a bid for your company, leaving you with a nice profit and a feeling that if only you could have held for a few more years, it would have been a much larger profit.

Before this happens, the company's value depends on stock buyers' interpretation of the company's presentations and its auditor's certified statements of its financial position. Which can and does fluctuate rather more than that of a long-established reliable dividend-paying concern. I'm always looking to buy quarters for dimes, although it's not easy to distinguish that from vice-versa in practice.

Personally I don't like companies with no hard asset value (debt > asset value, company value based exclusively on hopes for the future). But that's just me.

Answer 9

I think the real question is asking for a causal link between the business success of a company and its stock price, given that it does not issue dividends and has no plan of doing so.

The simplest reason is that a company that is generating operating profits can, at the direction of the directors, start issuing profits. And the size of those potential profits scales with how well the business is doing.

But even if that didn't happen, there are other ways to connect the business success to stock prices.

Suppose the stock prices fell massively to being dirt cheap, despite the business being successful. Then someone could go to a bank, point out how successful the business is and how much it is making, and get a loan against the assets of the business to buy every outstanding share in the business. Past a certain point, they have the right to take the company private.

At which point the business assets and its profits are owned by that private entity, which they in turn use to pay off the loans made to buy out the company. Any leftover profits are the people who bought the company out.

This actually happens with businesses that issue dividends or don't issue dividends. What I described above is a "leveraged buyout"; the leverage isn't an important part of it, other than it making the operation require much, much less capital than doing it without leverage.

On a smaller scale, this happens when a larger company buys out a smaller company, possibly without even taking out loans, because they want the smaller company's assets.

Then there is the raw power of owning or controlling a large profitable enterprise. There are people who want to go to space, build fun things, and change the world. They may be far past the point where their personal consumption of consumer goods is a motivation, but being able to get a company to build a rocket that flies to the moon is something they will want to do. To pull this off, they need to control their company and they need the company to have a positive cash flow. And as the task is larger than they have assets to fund right now, they need to make the company produce even more assets.

As the company grows in size by reinvesting in its own profits, the power that the company has grows. And each share represents a vote you have on what the company does with that power. While there are minority shareholder protections, they are not all that restrictive.

Someone who wants to control the power of a large, successful business will have to find people willing to sell shares in the company to them. Rivals who also want to control the business are less likely to sell it to them, so buying from institutional investors or retail investors ends up having to happen.

If a huge, successful, profitable company's share prices tanked completely, there would be someone willing to put up a "small" amount of money just for the rights to control what that huge behemoth of industry does next, even if they didn't want to harvest the profits.

All of these mean that if the price of a "successful" company becomes abnormally low, there are significant incentives for people to spend resources to buy up shares in the company. And none of these incentives are based off of "bigger fool" theory, ie, selling it in turn to someone else.

We then have a layer of speculation on top of this. Because of the foundation, betting on this company being bigger or more successful than it is right now should keep it almost always above thesholds for the above measures to kick in. Due to the efficient market hypothesis, the fact that a company below certain price thresholds is a really insanely good buy means that the price of the company resists going down to that insanely good buy price outside of situations of capital shortage.

Capital shortages happen during financial shocks. So you see the value of prices plummet in the stock markets. These tend to also happen in sync with "main street" economic shocks. Those with capital that aren't being stressed by the financial shock have to have enough to weather the "main street" economic shock as well, and if they do, can end up making a lot of money.

Answer 10

You're asking several questions here.

Lets back up a bit and consider what non-dividend stock is, why it might exist. After all, we can't decide if its foolish or fraud, until we see who might buy it, and why.

So, a non dividend stock is one that habitually retains earnings (profits) or absorbs losses, in the hope of stronger future growth. Literally, dont give away adollar today, because we can use it to make $1.50 tomorrow... or $5 next year.... or $40 in 30 years... or avoid future risk, or provide resources to fuel future profit streams/projects, or undertake R&D to protect our market position, or expand, or.... or.....

With that understanding, we can easily see why someone would invest. They feel the future prospects are better with that dollar retained, than with it paid out now. Or, more generally, they feel the company will be worth more in future if it habitually retains its cash than pays it out to investors.

If Im an investor, with $1 million in Amazon (or whatever other company you have in mind), perhaps I have a choice. They made profits equivalent to $70,000 on my $1m value investment. I can either be paid that $70k, or ask them to hold onto it and use it in their future business. If i can only invest that $70k at 3% and I believe Amazon profits can grow at 5% if they hang onto their earnings instead of paying them out, then logically I ask Amazon to do just that. If I want the certainty of cash in pocket, i dont invest in a company that believes in total reinvestment of earnings, because of the conflict over dividend policy.

So, your questions....

I'm  trying to see why a non-dividend stock isn't subject to the Greater Fool Theory. There's no intrinsic connection between the stock price and actual company profits without dividends.

Oh but there is. The connection is because stocks arent priced based on distributed earnings. They are priced based on sentiment and future value perceptions. That future value can be measured in terms of profitability and market position/prospects and culture and management competence and tax regime changes and a thousand other factors, whether or not the earnings are paid out.

Investors constantly estimate what a company may do, in terms of growth or change, and risks faced, in the future. What it pays out or doesn't, doesn't much change that exercise.

Now, we do assume that ultimately the value will be realised/realisable. That is, at some point somehow, Amazon (or whoever) will have a market value of $X per share, built up in part by resources created by all that retained earning, and we will see that materialise as cash.

But whether it does so in a year, a decade, or a century, that value is real. Unlike a ponzi scheme where it never was real in the first place, it was only a fake, a charade.

So my question is... suppose a stock price were to continuously drop despite high company performance (profits)... Is there something the shareholders can do to get some share of the profits? Only thing I see is voting for the board of directors in the hopes new members will put in a dividend plan? Is there anything else?

If the stock price is constantly dropping despite good (growing) earnings, then theres a problem. You have to ask why. Perhaps its in a sector falling out of favour (high street stores when internet channels got big). Perhaps the market doesnt like how its run. Perhaps its seen as not managing itself well, or vulnerable in some way to some serious business risk or upset.

As the market constantly re-evaluates the company, it may decide tomorrow, the business is worth a bit less than today (or not an enticing amount more). That may deter some investors, and lower the price.

If that continues, eventually there will be investors who hung on to it unduly, even while "the writing was on the wall", and rightly lose their money for being fools. There will be other investors who thought it might grow, took a calculated risk, lost some cash, re evaluated, and sold it on, based on a price that seemed fair on the day (to the market).

But at any stage, if enough investors want a dividend, they ultimately control the directors (by appointment/removal), and thus can make it so. But as they all invested in a company with a non-dividend policy, perhaps the one thing they may all agree on, is they dont want that....

Answer 11

Because dividends aren't the only way to profit from the stock, even if you never sell to other investors. Other opportunities include:

1. Future dividends - they might not always pay zero dividends
2. Stock buybacks (commonly done by Berkshire)
3. Merger/acquisition, which compensates existing shareholders
4. Bankruptcy, where assets are sold off to pay debts and the rest is distributed to shareholders

So my question is... suppose a stock price were to continuously drop despite high company performance (profits)... Is there something the shareholders can do to get some share of the profits?

They can always choose to refuse to sell and continue making profits using the four mechanisms described above. Though its pretty rare for highly profitable companies to drop in price for more than a few months in a row.

I'm trying to see why a non-dividend stock isn't subject to the Greater Fool Theory

Its not subject to the Greater Fool Theory because those trading on stocks have access to a great deal of information about the company, vetted/audited by the SEC and subject to harsh punishments if caught lying to their investors. Said investors might be making a mistake (no one can reliably predict the future) but they're basing their beliefs on a concrete set of data rather than the idea of a "greater fool" buying it up before it all goes up in smoke. This is in big contrast to true Ponzi schemes like the one run by Bernie Madoff where he lied to his investors for decades in order to keep up the charade. Once you remove truthful information from the equation, the prediction mechanism no longer works and you get a graph like this (the turkey example is from Nassem Taleb's writing):

If Bernie Madoff was forced to keep his books open, very few people would agree to invest their money with him as they would see he's just stealing it rather than investing it profitably.

Answer 12

What you fail to realise is that usually if a company does not declare a dividend it is because they think the money could be better spent on some other economic activity. Usually if you want to get involved in the nitty-gritty of a specific companies operation you can go to the AGM and hear what the directorship plans are for the year. If there is plans not to declare a dividend then there should be a discussion on what potential profit the new venture may entail.

Answer 13

The question is a legitimate inquiry into what one buys when buying a stock. A share of a stock gives partial ownership of the company. Owners, as a group, have the ability to change the board of the company. So, on the most basic level, buying a stock is buying a voting right. While most people don't think of it that way, legally that is what purchasing the stock buys you.

There are various reasons people (or entities) may buy company shares. Dividends or potential dividends are only some of them. Having voting rights gives shareholders a say in how a corporation is governed. This may give a sway in

• whether dividends are paid
• whether a merger is approved
• which ethical restraints a company adheres to
• whether a certain product line or R&D (research and development) is pursued

The last line is not as rare as it may seem to a casual investor.

For example, most drugs are taken through FDA approval by corporations formed specifically for that purpose. And, because the process is very costly, the risk of the process is often mitigated by making such corporations public. If the approval succeeds, the value of the corporation increases (usually quite a bit) and the corporation (whose main asset is a patent on an approved drug) gets bought by a pharmaceutical conglomerate which has a network for distributing the drug.

This gives early investors a reason to gamble on the corp's eventual success. While there is no dividends at the end of the line, the eventual buyer is not a "greater fool," but rather a conglomerate which has the ability to make the assets of the corporation more valuable than they are on their own.

Answer 14

A dollar bill has the same intrinsic value as a 100 dollar bill yet I'm sure you'd rather have someone give you the latter; the entire premise of this question is completely flawed. Perception is reality, and in everyday life you will constantly encounter countless things with low intrinsic value yet are highly valued, the fashion industry in particular is built around this concept. Nobody buys a $10,000 watch because it tells the time better, in fact it does worse than even a 5 buck one that uses quartz rather than mechanical movement.