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Eureka: The dividend puzzle Eureka: The dividend puzzle
by Akli Hadid
2017-11-19 09:48:47
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This puzzle in economics wants an explanation on why stock-listed companies who pay dividends tend to have higher valuations by investors. Before I define the different concepts, let me give you a very quick reason: investors, especially professional and experienced ones, tend to know how – freaking – hard it is for any company to achieve any form of profit.

div01Now to the semantics. Companies have different sources to raise funds. One way is the CEO uses his personal savings to start a company. Another way is to go to private banks or investment banks and ask for a loan that will be repaid with interests. One way is to list the company at the stock market, collect shareholder money pay the shareholders back. Some companies provide dividents which is parts of the profits to shareholders.

Now as I emphasized before profits equals sales minus operational costs. Operational costs are everything from production to packaging to wages to real estate to logistics to transportation, to anything that you need to keep your company up and running. Investors, especially those who have been in the business for a long time, know that a lot of companies fail to ever break even. That is some companies linger on for years, but sales never really cover the operational costs.

So a company that provides dividends is a company whose sales technically are superior to operational costs. This is a gem in itself, because as I said, the percentage of companies whose sales are superior to operational costs is not high, somewhere between 30 and 60 percent. The reasons are varied, but a lot of times involve poor mastery of the production line, poor mastery of the market, failure to overcome hurdles and mismanagement.

So as an investor, I would know that a company that provides dividents is a company that is in the 30% or perhaps even in the 10% if the dividends are high, in the 1% if the dividends are very high. As an investor I know that a lot of high performing companies are not listed in the stock exchange and that only a handful of companies are listed in the stock exchange and manage to turn the investment into profit. So naturally, companies that make profits tend to be higher rated and tend to have higher valuations than other companies.

Why are those companies who aren't making profits still listed in the stock exchange? Some promise that it takes time for them to break even, others say that their stock should be viewed as a long term rather than a short term asset. Naturally, such companies can be valued, but on average, when companies start making profits and transforming them into dividends, their stock prices go up.

There is something of a logical issue here, since perhaps companies who are not making profits should get more shareholder money than companies who are making profits, as companies making profits would want to opt out of redistributing their profits in the forms of dividends and would like to use their profits for something else. But, naturally, where shareholders see money, they tend to flock up to get it, thus the stock price goes higher. If I tell you this stock has money in it, you would be willing to pay more to have it. Simple.

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