There are many ways to value a stock without dividends. While dividends are the only money paid directly to shareholders, companies also have earnings that usually lead to capital gains for the stock. For stocks without dividends, earnings are often used to evaluate the company.
There is a great difference between a company with strong earnings that chooses not to pay a dividend and one that cannot afford to pay. However, even struggling companies usually have other assets that can be valued.
Key Takeaways
- There are many ways to value a stock without dividends.
- A company with high earnings and a low price will have a low P/E ratio regardless of dividends, and such a stock could be a good buy.
- Growth investors prefer to focus on metrics like earnings growth.
- The assets and liabilities of a firm can be summed to give the book value, and stocks priced below book value frequently perform well.
- Stocks without dividends can be excellent investments if they have low P/E ratios, strong earnings growth, or sell for below book value.
The P/E Ratio
The price-to-earnings ratio or P/E ratio is a popular metric for valuing stocks that works even when they have no dividends. Regardless of dividends, a company with high earnings and a low price will have a low P/E ratio. Value investors see such stocks as undervalued. A company with high earnings and a low price has the potential to convert those earnings into dividends, which gives it value.
Earnings Growth
Growth investors prefer to focus on metrics like year-over-year (YOY) earnings growth. Where earnings are going is more important to these investors than where they are right now. If a company's earnings went up 60% last year and 50% the year before, that is a sign the company is strong. If earnings keep declining, high dividends are just a bribe to buy and hold the stock of a company as it goes out of business.
Firms can make money without giving out dividends. Frequently, young and growing firms prefer to reinvest their earnings in their business instead of issuing dividends. That can also create tax advantages for investors. Dividends often qualify for low long-term capital gains tax rates. However, retained earnings and price appreciation do not require investors to pay any taxes until they sell the stock.
Book Value
Book value provides a way to value the stocks of companies that have no earnings and pay no dividends. Every company has assets and liabilities on its balance sheet that can be summed to give the book value of the company. Firms that are currently losing money and cannot pay dividends may see their stock prices fall below book value. At the very least, stocks priced below book value make tempting takeover targets.
The stocks of firms with long histories of success were often good buys when their prices fell below book value. They frequently returned to profitability later on, and their prices zoomed up far beyond their book values. Warren Buffett placed great emphasis on book value during most of his career. However, he became skeptical of its continued usefulness in his later years.
Reasons to Buy Stocks Without Dividends
In the past, many associated growth companies with non-dividend-paying stocks because their expansion expenses were close to or exceeded their net earnings. That is no longer the rule in today's modern market. Other firms have decided not to pay dividends under the principle that their reinvestment strategies will—through stock price appreciation—lead to greater returns for the investor.
Thus, investors who buy stocks that do not pay dividends prefer to see these companies reinvest their earnings to fund other projects. They hope these internal investments will yield higher returns via a rising stock price. Smaller companies are more likely to pursue these strategies. However, some large caps also decided not to pay dividends in the hopes that management can provide greater returns to shareholders through reinvestment.
A non-dividend paying company may also choose to use net profits to repurchase its shares in the open market in a share buyback.
Finally, there is book value. An unprofitable company with lots of assets may be priced below book value. When prestigious firms with long histories fall below their book values, they often rebound spectacularly.
FAQs
The price-to-earnings ratio or P/E ratio is a popular metric for valuing stocks that works even when they have no dividends. Regardless of dividends, a company with high earnings and a low price will have a low P/E ratio. Value investors see such stocks as undervalued.
How do stocks have value without dividends? ›
Companies that don't pay dividends on stocks are typically reinvesting the money that might otherwise go to dividend payments into the expansion and overall growth of the company. This means that, over time, their share prices are likely to appreciate in value.
How to calculate valuation of stock? ›
The most common way to value a stock is to compute the company's price-to-earnings (P/E) ratio. The P/E ratio equals the company's stock price divided by its most recently reported earnings per share (EPS). A low P/E ratio implies that an investor buying the stock is receiving an attractive amount of value.
How do you calculate the value of a stock using dividends? ›
How Does the Dividend Discount Method Work?
- DDM Formula:
- The Value of the Stock = (Expected Dividend per Share) / (Cost of Capital Equity – Dividend Growth Rate)
- OR.
- DDM stock valuation = CF / (r – g)
- $1.50 / (0.06 – 0.04) = $75 per share.
- $1.50 x (1 + .04) = $1.56.
- $1.56 / (0.06 – 0.04) = $78 per share.
How do you calculate the price of a stock? ›
How is the stock price determined? When a company enters the market, it undergoes valuation during an initial public offering (IPO). After this event, the total value of the company is determined. Dividing this total value by the number of issued stocks gives you the price of a single share.
How to value a stock that does not pay dividends? ›
The price-to-earnings ratio or P/E ratio is a popular metric for valuing stocks that works even when they have no dividends. Regardless of dividends, a company with high earnings and a low price will have a low P/E ratio. Value investors see such stocks as undervalued.
How do you calculate dividends if not given? ›
How to calculate total dividends. The formula for calculating how much money a company is paying out in dividends is simple — subtract the net retained earnings from the annual net income. You can find the income and earnings from the company's balance sheet and income statement.
How to properly value a stock? ›
Price-to-earnings ratio (P/E): Calculated by dividing the current price of a stock by its EPS, the P/E ratio is a commonly quoted measure of stock value. In a nutshell, P/E tells you how much investors are paying for a dollar of a company's earnings.
What is the correct method of valuing stock? ›
The most common way of valuing a stock is by calculating the price-to-earnings ratio. The P/E ratio is a valuation of a company's stock price against the most recently reported earnings per share (EPS).
What is the formula for valuation of shares? ›
The formula for valuation using the market capitalization method is as below: Valuation = Share Price * Total Number of Shares. Typically, the market price of listed security factors the financial health, future earnings potential, and external factors' effect on the share price.
Companies that do not pay dividends on their stock usually reinvest the money that would have gone to dividend payments towards the company's expansion and overall growth. This implies that their stock prices will rise in value over time.
What is the formula for value per share of a stock? ›
Book Value per Share: It is calculated by dividing the company's equity by the total number of outstanding shares. Market Value per Share: It is calculated by considering the market value of a company divided by the total number of outstanding shares.
What is the formula for calculating dividends? ›
The dividend per share is calculated using a simple method. To calculate DPS, divide the entire number of dividends paid by the company by the total number of shares held. The annualised dividend is the total amount of dividends given out during the year.
How to calculate the real value of stock? ›
P/E Ratio. The P/E ratio is commonly used to know what the valuation of a company is. The price-to-earnings ratio is measured by dividing a stock's price by earnings per share (EPS). A more direct way to measure the P/E ratio would be to divide the market capitalisation by the total earnings.
What is the formula for stock valuation? ›
The formula for valuing a stock to be held one year, called the one-period valuation model, is P = E/(1 + k) + P1/(1 + k), where E is dividends, P1 is the expected sales price of the stock next year, and k is the return required to hold the stock given its risk and liquidity characteristics.
How do I calculate the value of my shares? ›
Calculating the value of a shareholding
To value a shareholding you will need to multiply the number of shares owned by the price per share.
Does Warren Buffett buy stocks without dividends? ›
Many wise investors believe that dividends are the key to long-term investing success. Warren Buffett certainly fits into that category. He doesn't make big bets on which way a stock will move over the next quarter or even the next year. Instead, he focuses on quality companies sustaining dividends.
Do all value stocks pay dividends? ›
Many value stocks pay out substantial amounts of cash as dividends to their shareholders. Because such businesses lack significant growth opportunities, they have to make their stock attractive in other ways. Paying out attractive dividend yields is one way to get investors to look at a stock.
Do stocks lose value when they pay dividends? ›
With dividends, the stock price typically undergoes a single adjustment by the amount of the dividend. The stock price drops by the amount of the dividend on the ex-dividend date. Remember, the ex-dividend date is the day before the record date.
What is the reason for no dividends? ›
Highlights. Firms pay no dividends due to cash constraints and investment opportunities. Firms do not pay dividends because of poor profitability and earnings. Firms avoid paying dividends due to the cost of raising external funds.