In my recent outline on JW's investment advice (see http://ccszeto.blogspot.com/2012/04/avoid.html), my friend VW commented that companies that do not pay a dividend may not be excluded. In fact, from the original idea of Benjamin Graham, companies that pay less dividend and use the money for development should be preferred.
I must say that's entirely correct - at least for profitable and efficient business.
For those with some background knowledge in finance and company valuation, let's consider a simple example: If a stock is trading at a price-to-earning (PE) ratio of 10, and the return of equity (ROE) is 20% (implying a price-to-book, or PB, ratio of 2), giving away all profit as dividend means that you get $10 yearly for every $100 of investment. If you put that money back to the stock, the portfolio would be growing at 10% per year, and you own $110 of that stock next year.
However, if the company pays no dividend and keeps the money for expansion of its business, for every $100 of the original investment, the profit next year would be $12 ($60, the new book value, times 20% of ROE). If the PE ratio of this stock stays at 10, the price of the stock would rise to $120 next year.
PS. The method I outlined is a simplified version of the discount cash flow, one of the most commonly used method for company valuation.
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1 comment:
In this world full of financial foul play and crooked accounting, track record of 現兜兜 dividend payout (excluding special dividend) becomes one of the most important valuation tools for value investors.
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