"The Need for New Capital Expenditures Limit Stock Dividends"

capital expenditures - man offering tropical drink

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Most companies go through similar cycles.

They start out small. They must pull themselves up by their bootstraps, so they need to reinvest all their net earnings. They don't pay out dividends to shareholders because they need that money to pay their expenses.

Some types of companies find it difficult to pay out dividends even when they're bigger. They have a need to continually spend as much as possible on research and development or on capital expenditures.

Capital expenditures refers to new factories, new equipment for those plants and similar items.

All Companies Need to Make Capital Expenditures Out of Retained Earnings

In some industries, the competition is so intense that any company that does not keep up with the others in their field, falls behind

This is a problem with many high tech or high tech dependent industries.

If the factory of The Wonderful Acme Company must product 100 widgets an hours to compete, and a new widget making machine comes out that would allow you to make 150 widgets an hour, management of The Wonderful Acme Company has no choice but to buy one of those new widget making machines, even though it costs the $60,000 of their profits that they wanted to pay out to their shareholders.

Because if they don't buy the machine and their competition does buy one, because they paid their shareholders the money instead -- they're competitive toast.

Investors Do Better in Companies That Don't Need Constant Capital Improvements

Same with computers. We all know that bigger and faster PCs are always being reintroduced

Some capital expenditures are always necessary, because all equipment eventually wears out and must be replaced.

But don't consider investing for income in companies that must continually reinvest all their earnings just to stay ahead of the competition.

Their stock price may go up, but they'll never pay a dividend.

And income is what we're here for, remember?

Using retained earnings for capital expenditures instead of paying dividends can make sense when they truly grow the company's main business, but it still hurts shareholders.

Closely related is the desire of companies to spend their profits on other ways they hope will make money in the future: Reinvestment.

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