Companies make money, or at least they try to. But what exactly do they do with that money?
Imagine that the NHL Demolition Co. (ticker: PUCKS), specializing in property destruction, earns $15 million on sales of $120 million this year. It can do four primary things with that money:
- Pay out all or some of its profits to shareholders as a cash dividend. (Matt Richey expounds on the power of dividends.)
- Buy back some of its own shares on the open market. Doing so boosts the value of the remaining shares, because the company's worth ends up being divided among fewer shares. (Learn more about buybacks in Zeke Ashton's article on the buyback yield.)
- Plow that money into its ongoing operations. In the case of our fictional company, that could mean renting more property to destroy or hiring more destroyers.
- Invest in other business ventures. For PUCKS, that may include buying a smaller demolition company or a related company, such as a recycling enterprise.
A publicly traded company's main priority should be 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.
Lean more about how to make sense of financial statements by checking out our "Crack the Code: Read Financial Statements Like a Pro" how-to guide. Give any of ourhow-to guides a whirl; several of them are absolutely free.