What Companies Do With Their Earnings

Companies make money, or at least they try to. But what, exactly, do they do with that money? Read on.

Imagine that the NHL Demolition Co. (ticker: PUCKS), specializing in property destruction, earns $15 million on sales of $120 million this year. There are four main things it can do with that moola:

• Pay out all or some of its profits to shareholders as a cash dividend. (Learn about the power of dividends here.)
• Buy back some of its own shares on the open market. This boosts the value of the remaining shares, as the company's worth ends up being divided among fewer shares. (Get the skinny on buybacks.)
• Plow that money into its ongoing operations, renting more property to destroy or hiring more destroyers.
• Invest in other business ventures, perhaps buying a smaller demolition company or a related company, such as a recycling enterprise.

To give you an idea of what some companies do dividend-wise, General Electric (NYSE: GE) pays out nearly 60% of its earnings in dividends, while McDonald's (NYSE: MCD) pays out around 30% and Bristol-Myers Squibb (NYSE: BMY) paid out more than 100%. (Payouts near or above 100% suggest proceeding with caution, as they may be unsustainable.) On the stock buyback front, there's a lot of activity, with companies spending more than $400 billion buying back their stock in 2006. Pfizer (NYSE: PFE), for example, recently announced it will buy back up to $10 billion of its stock in 2007, and Home Depot (NYSE: HD) is buying back some $3 billion worth of its shares.

A public company's main priority is to build value for shareholders. To do that, it must determine which strategies will generate the biggest bang for the buck. Buying back shares, for example, isn't too smart if the shares are currently trading at grossly overvalued prices.

You can learn more about how the financial world works in our Investing Basics area and in our Fool's School.

Meanwhile, if you're interested in learning more about companies that make high dividends a priority, take a look at our Income Investor newsletter. Each month, you'll get recommendations of companies that combine solid current income with strong prospects for capital appreciation. Take a look with a free trial today with no obligation.

Longtime Fool contributor Selena Maranjian owns shares of General Electric, Home Depot and McDonald's. Home Depot and Pfizer are Inside Value selections. The Fool has a disclosure policy.