Q: Why don't all stocks pay dividends? Should I avoid stocks that don't pay a dividend?
There are several things companies can do with their profits, and paying a regular dividend is just one of the options.
Before doing anything else with its profits, a company needs to make sure its capital needs are provided for. For example, if some of the company's equipment needs to be upgraded in order to stay competitive, this is (and should be) the top priority. Once these needs are met, there are a few things management can decide to do with its excess cash.
- Reinvest the profits in the business: This can mean expanding its operations or acquiring a competing business. This is Warren Buffett's preferred use of capital, and is the main reason why Berkshire Hathaway doesn't pay a dividend.
- Pay a dividend: You may have noticed that mature businesses are far more likely to pay dividends than rapidly growing companies. For example, AT&T pays out about two-thirds of its profits as dividends, as it has limited growth potential and doesn't need a ton of money to cover its current capital needs.
- Buy back shares: This is the other way companies can return capital to shareholders. There are several potential advantages to buybacks, especially if shares are trading for less than their intrinsic value.
- Do nothing: If none of these three options seem appealing to management, the company can choose to stockpile its cash for a rainy day.
The bottom line is that dividends are just one way companies can put profits to work for shareholders, and many stocks that don't pay dividends can still be excellent long-term investments.
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