"Reinvestment of Capital Can Take the Place of Paying Dividends to Shareholders"

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Some companies are big and established enough that they don't have to continually make huge capital expenditures just to survive.

They have enough money left over after paying taxes that they they could pay a dividend, but they choose not to.


Reinvestment of Company Capital Can Help Grow the Business

Well, often management believes that although the company's survival is not at stake, they do know how to reinvestment that capital so that it will make more money for you than you could by yourself

Let's go back to The Wonderful Acme Company.

They now have $120,000 net profits after paying taxes.

Maybe the Board of Directors wants to pay a dividend, but the CEO says instead, "Listen, I just heard that we could buy The Small Terrible Company that makes our supply of wadgets. They're losing money, they can't afford to upgrade their equipment. But we have the experienced management. We can turn The Small Terrible Company into a money maker. I estimate we can double their sales and make a net profit of 10% the first year and 20% the second year."

Some Corporate Management Teams Would Rather Waste Capital Than Send it to Shareholders

The Board of Directors decides that The Small Terrible Company would be a good investment, and authorize the investment

If it works out, maybe next year The Wonderful Acme Company doubles its profits and its stock price goes up three times.

You could never have made that much money yourself, out of the $52.50 in net dividends (after double taxation, remember) you received.

So you're happy because the market price of the 100 shares you own of The Wonderful Acme Company have tripled.

Smart Reinvestment of Capital Does Increase Business Value

A good real life example is Microsoft.

The company was formed in 1975. It went public in 1986. It had tremendous success for many years. It bought out many high tech companies which added to Microsoft's bottom line and helped increased the price of their stock.

Yet Microsoft never paid a dividend until 2003.

Prior to that, you invested in Microsoft solely for capital gains, not for income.

Another good example is Berkshire Hathaway

Warren Buffett firmly believes that he can invest your money better than you can.

And given his track record, he has good reason for thinking so!

Berkshire Hathaway has paid a dividend only one time (in 1967) since he took it over, and Mr. Buffett claims that happened only because the Board of Directors took a vote while he was in the bathroom.

Mr. Buffet Said He Would Pay Dividends if the Government Eliminated Double Taxation of Dividends

Furthermore, he buys companies that are generating a healthy flow of cash profits.

So he's been successful by buying companies that do pay well.

Of course, not all company managements are equally skilled at increasing shareholder value. Some frittered away the company's money and their stock owners would have been much happier with cash in their pockets.

Some "Reinvestment is Really Agency Costs

Too many company managers incur what're called "agency costs" -- they waste money just because they have it

Reinvestment of capital uses funds -- in smart and stupid ways -- that are then unavailable for paying out as stock dividends.

They don't always buy other companies -- sometimes they buy their own company. That is, they do a stock buyback.

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