[Ologn]

> Using p/e to value growth companies doesn't work too well. The "E" in the ratio changes too fast.

In 1934, Benjamin Graham and David Dodd published "Security Analysis" which laid out the basis of modern thinking on proper fundamental stock price, both by academics and by mutual fund managers. What you're saying completely contradicts that.

Something else is forgotten - the real price is not determined by the p/e ratio but in something even more concrete - the price/dividend ratio. Enron might be fudging their books, but nothing fudges the quarterly dividends. Price/earnings is already an abstraction of what determines the real price - the price/dividend ratio. You're talking about abstracting things yet further - it reminds me of the late 1990s when people talked about price as related to "eyeballs".

It's true that a p/e ratio is meaningless when a company is very small - before product/market fit and so forth. But P/E has forever been used to value technological growth companies. Technological growth companies are not a new thing - there were companies like Cisco in the 1990s and like Polaroid in the 1970s. High growth companies have high p/e ratios. It's already abstracted from price/dividend to price/earnings.

Then there are companies like Amazon, which are a whole other tangent off this.

[wtvanhest]

P/E ratios are just one factor that professional investors use to analyze companies. P/E ratios may be really high while not being alarming when it is in the company's best interest to invest in growth.

When the company can invest excess profits (contribution margin) in growth, the company can make zero money in earnings while still rapidly growing revenue. That is a really great situation and if you do not buy that stock because of the high p/e ratio, you will have missed a major opportunity.

Dividends go a step further. If a company believes that paying dividends is the best use of the company's capital, that means the company has theoretically run out of growth opportunities to invest in.

Understanding finance is a lot more complicated than reading and understanding a single book written in 1934. If you want to learn a lot more about how unimportant P/E ratios are, you can read about factor based stock analysis or financial econometrics.

[steveplace]

There is growth investing and there is value investing. One isnt the end-all, and both have merits.

I am more of the growth side of things so i will look at a metric like price to sales or sales growth to get a better idea on what investors are expecting.

My point here I guess is if youre looking at a growth stock, you should be looking at how eps are growing and how they will grow in the future, not the price right now.

Maybe its that i have seen too many scream about p/e on something like NFLX or CRM or AMZN (because they don't back out capex)... And then the stock contiunes to run as earnings grows.

[amunicio]

The price earning ratio is useful to compare companies in the same industry that are targeting the same growth level.

If P/E was any good indicator of value (in the absolute) the total market cap of Amazon should have been close to $0 during any of these quarters when it barely broke even.

I'm not implying that the P/E is worthless, just that it should be carefully applied and in some cases it shouldn't be applied at all.

[JoeAltmaier]

I've heard this idea that dividends determine a stock value, but I've never believed it. I guess for some definitions of the word 'value', because the dividend, if any, has little or nothing to do with the bid or ask prices on the exchange. When dividend time comes near (for annual dividends) the stock price ramps up by the expected/announced dividend, then poof! it drops by that price after. So for most of the year the potential dividend is factored in at nearly zero$.

Also preferred shares issue dividends, right? So all the rest - what is their 'value' by this strange definition?

Folks can pretend there is some holy, true value of the stock that can be determined from the history of dividends. But good luck buying or selling your shares based on that number.

[jacquesm]

There are quite few direct roads to investing based on dividends alone and there are also a whole bunch of products directly targeting high dividend yield stocks. Surely the people buying/selling those stocks and funds are buying and selling based on that number.

It's just a different strategy, not very popular in the startup world but for more established companies it is not unheard of.

[JoeAltmaier]

Sure that makes sense. But academics insist that all stocks have value based on their dividends. My local prof of finance (and old high school friend/poker buddy) is one. I can't fathom how the ivory tower types come up with this nonsense.

[prostoalex]

Short-term vs long-term investment. If the plan is to buy in the morning and flip in the afternoon, the dividend ratio does not matter. If the plan is to buy and hold for years ahead and generations to come, the piece of paper you paid some cash for better kick back some cash in the process.

This is, of course, pure academic abstraction. The reality kicks in and you see both unhealthy companies producing healthy dividends (for their private equity funds, usually by raising debt) and healthy companies paying no dividends at all but reinvesting into growth (AMZN).

[jacquesm]

> But academics insist that all stocks have value based on their dividends.

That's a strange statement (by the academics, not by you!) since quite a few companies stocks are traded that have to date never issued a single dividend and that may not issue dividends for a quite a while to come. And still somehow the market seems to be able to assign a value to those stocks.

I think that one way of interpreting this is that - just like with start-up valuations - as long as you're growing / adapting / investing dividends are out of the question and the value is mostly based on the story and the dream. Turnover and other numbers are useful but ultimately not as useful as money returned to investors (otherwise, why invest at all?). But once the moment of dividend arrives (and growth / investment) have stopped and the company is now in its middle age that those dividends will be the marker used to re-calibrate the value of the stock. Dividends are a lot easier to use as an input into a formula than dreams and stories which are just repackaged hope.

That's one reason why I find it nearly impossible to put a hard number on the value of a start-up, it's essentially asking for a crystal ball.

[tptacek]

It's not a strange statement. Stocks that don't pay dividends would still appreciate because investors are pricing in either the dividends the company will pay in the future, or the value the company will have to the dividends of the company that will eventually acquire it.

[JoeAltmaier]

Again insistence that stock traders are all about dividends, on no evidence whatsoever? Folks trade stocks because the bid and ask overlap; that's it. There's nothing else going on, except in people's heads. Fictitious future dividends are ... fictitious! Good luck trying to sell your stock for anything but what its going for on the day you sell. Any cries of 'but dividends! Its worth X!" will be drowned out by the marketplace.

And the evidence points to, there's no accommodation for dividends in the price. Stocks ramp up in the month before dividends are issued; drop that day. That's all the market does to accommodate dividends.

[damien]

It's likely talking about all future dividends (discounted for time value). Startups will naturally reinvest their earnings to grow, but at some point, pursuing growth will be too costly and the best use of their earnings will be to return it to the owners as dividends.

If a company were guaranteed to never return anything to owners, then it would be more like speculating in the future value of a baseball card than an actual investment.

It may not be a practical way to calculate value, but it's not crazy either.

[eastern]

Indeed. Microsoft paid it's first dividend only in 2003, a good 17 years after it IPO'ed. http://www.nasdaq.com/symbol/msft/dividend-history

There's this too: http://www.nasdaq.com/symbol/goog/dividend-history

[harperlee]

That needs to have been taken out of context.

Probably what they insist on, is that there is this Gordon valuation model, which, long-term, should apply to any company that gives a dividend, and it's based on this idea that for a company to be worth anything for a minority investor without any control of the company, it needs to have a dividend - which is the only return on investment that such investor will receive, apart from profit for selling in the future.

[JoeAltmaier]

Nah, simply blind insistence that there every stock is worth only what its dividend pays. I don't know why he thought that; but apparently the idea has currency. Look at the comments to this thread!

[wfunction]

> But academics insist that all stocks have value based on their dividends.

Makes sense to me. If everyone knew a company would never pay any dividends there why would anyone pay for any share of the company? It would be worthless.

[JoeAltmaier]

Except it happens all the time, and the shares are not worthless.

[syllogism]

Dividends can underwrite the value even if never issued, the same way a government guarantee can make debt 0-risk even if the guarantee is never exercised. Contrast with a "tulip economy", like bitcoin, where there is no intrinsic value — only investor sentiment/expectation. Bitcoin and gold are worth money because you expect others to expect others to expect etc it to continue to be worth money. Time-discounted expected future dividends act as shared knowledge: everyone knows that if the price dropped below a certain point, the company can start issuing dividends and the price would immediately recover. Because everyone knows that, the price never has to drop that far, and it's never necessary.

[zodiac]

Not really, it's the expected future value of dividends (plus the value in assets of the company and in voting rights, but these are normally much smaller than the value of the future value of dividends). People buy growth company stocks based on the belief that in 10 years, the company will be huge and they'll start paying dividends.

> Also preferred shares issue dividends, right? So all the rest - what is their 'value' by this strange definition?

Common stock can pay dividends as well.

If you still don't believe me, let me ask you - if tomorrow Google announced that they would never ever pay a dividend ever, how much would their stock be worth? Why would anyone buy Google stock in that case?

[lmm]

Google did say that, when they first went public. The markets ignored it (and it seems they were right to; Google may not technically have paid a dividend but they reverse-span-out Alphabet which has, which is economically the same thing).

[lmm]

Financiers are perfectly happy to value things quite abstractly. I mean, you can buy CDS on Kazakhstan - that is, insurance on bonds that don't exist. And they trade, at reasonably stable prices.

Exactly how much is in this year's dividend doesn't really matter most of the time - if they pay a penny less this year that's one more penny in their vaults for them to pay out next year (or invest in the business and pay out further down the line). I mean, what else are they going to do with it? (The exception is generally poorly managed companies who might waste the penny instead - and in those cases activists often can dramatically increase the price by encouraging the company to pay a big dividend right now and keep less cash in the bank).

But the dividends are where the rubber meets the road, the foundation on which any valuation ultimately rests. And in the long run companies either die or become the kind of stable, dividend-paying stock that makes less headlines and is valued pretty directly on PE that actually makes up most of the market.

[fredkbloggs]

Have you ever heard that price is what you pay, and value is what you get?

The people who understand this look at dividends. The rest buy companies like Amazon for silly multiples.

P.S. Preferreds may or may not pay dividends. The preferreds that VCs get almost never do. If you own preferreds that do, you probably value them the way you value anything else: present value of future payments.

[prostoalex]

Dividends is just one way of returning money to shareholders. It's preferred by investors buying stocks for recurring income, as it allows for a simple buy-and-hold strategy that kicks back some income on a regular basis.

Stock buybacks is another mechanism, and is preferred by growth investors buying equities out of taxable accounts, as it gives greater control in regards to capital gains, tax loss harvesting and various other tax events.

[fredkbloggs]

Stock buybacks by definition cannot by themselves reward shareholders. They are by their nature an enticement to become an ex-shareholder, and a reward to those ex-shareholders.

The fact that remaining shareholders are, ceteris paribus, "entitled" (but not really) to a larger share of the company's profits as a result is moot if the board never distributes the profits to them. In reality, you're entitled only to what the board decides to give you. For my part, if the board wants to buy me out, I'm happy to take them up on it. The incentives favor becoming an ex-shareholder, so ex-shareholder I shall be.

[JoeAltmaier]

That sounds like 'sour grapes'. Sure, folks can pay crazy prices but not me! I won't participate in all that profit nonsense.

The only value you usually get from most shares, is what you sell it for. And that depends only upon the market. Not some academic definition of 'value'.

[fredkbloggs]

> That sounds like 'sour grapes'.

Believe me, it isn't. I'm no trader and have no interest in speculation. I'm perfectly happy collecting my dividends (that profit "nonsense", as you put it) while you boys do your thing.

> I won't participate in all that profit nonsense.

Riddle me this, then. A company is founded. Takes a few rounds, goes public. Billions of its shares are traded for years. Then it goes bankrupt, and all those shares are canceled.

Who profited? Trading is a zero-sum game by its nature. The profits, if any, accrued to those who were paid dividends. For every trade, show me a winner and I'll show you a loser.

It's fine to bet on the horses. Good fun, fresh air and a pleasant day at the track. Nothing wrong with it. Maybe you'll even get lucky! But if you want to make the sure money, you're better off owning the track... or the horses.

> The only value you usually get from most shares, is what you sell it for.

This couldn't possibly be more wrong. As I just explained, the true and total value (using your definition of CASH MONEY) of any corporation is the dividends it pays. Otherwise, there's a loser for every winner in the trading game. If you only own shares that don't pay dividends, I can understand how you might fall into this way of thinking, but that doesn't make it right.

This is a product of various cognitive biases, among them the Dunning-Kruger effect, the bandwagon effect, recency, groupthink, survivorship, and many others. It feels good to believe that one is a better-than-average trader, that one has skill in trading and can consistently and reliably make money doing it. Because it's often possible to make money without skill, even for periods of time that are large fractions of a human life, it's easy to draw that conclusion, especially when it seems like everybody is making money trading as is often the case in bull markets. Because one is making money trading (or believes he is; it's easy to overlook the bad trades if you don't keep a good accounting, and even easier to imagine unrealized market price gains as if they were CASH MONEY when in fact they are nothing), it's easy to assume that it's the result of skill. But most traders have zero or negative skill, and like the gambler who always lets it ride, will eventually go broke.

I don't really care whether you trade. I don't really care whether you make money or lose money trading (the odds are not in your favor). I certainly don't care what assets you choose to own. But don't tell me that the income I receive from owning -- not trading -- solid businesses isn't profit, or that your way is better than mine. When people start talking like you, I begin to wonder if we once again have a generation of traders in the markets who have never experienced a crash or a secular bear market. Those unrealized gains can turn into losses and margin calls awful fast when things go to shit. Yet shockingly often, even while prices crater, the dividends keep coming.

[harperlee]

Trading, as in "people crazily trying to profit from a dumber / slower counterpart" is zero sum.

But trading, as in, go to market and exchange money for another thing, can be a positive-sum game. If both participants in the exchange have different risk profiles, the exchange might make both of them happy - that's why they go to market, and expect not to be ripped off.

An easy example are future markets (the risk of high prices is good for the guy that has oranges, bad for the guy that makes juice).

Another example, with stocks, is putting your money in diversified assets. If all I have is stocks from company A, and you have only company B shares, and even if both companies are exposed to the same risks, it's good for both of us to interchange stock. If the CEO gets a heart attack, neither of us gets impacted wholly.

The point being: as you can't predict the future, the fact that one party ended up winning is not sufficient condition for the whole thing being a zero-sum game, unless you restrict "the game" to be something smaller than the intentions of the agent, which is dumb.

[JoeAltmaier]

Yet the stock market goes up 15% every year (on average) for the last century. Where does that come from? The 'zero-sum game' fiction is ridiculous urban legend. The price depends upon a market, and I sell to a different agent than I bought from, at a different price - the transaction is nothing like 'zero sum'.

Most stocks don't issue a dividend - yet they have solid, stable prices. Folks use a variety of valuation techniques, but mainly the present value of expected future value. Which means what you think you could sell it for in a year.

Have a nice time with those dividends - but my retirement stock portfolio is worth something when I sell it for income when I'm retired. The dividends are a tiny part of that.