
Originally Posted by
xanfiles1
Both of you are wrong.
Stocks 101
Lets say, you want to open an Ice Cream Shop, but don't have the Money
I'll lend you $100 (to keep the Math Simple) and you issue me 1 share of ICS and 50% ownership (You keep the other share). So totally there are two shares
After Year 1, your Ice Cream Shop Has
Revenue = $200
Cost = $100
Profit aka Earnings= $100
ICS Earnings Per Share = $100/2 or $50
ICS can do three things with $100
1) Distribute the $100 to the shareholders fully (each share gets $50). I as a shareholder can take that $50 and put in a bank and earn 2% or have to find another budding entrepreuner for better returns
2) ICS can come to me and say. "Look, ICS made you lot of money in Year 1". We can actually open another Ice Cream Shop and earn the same kind of profit".
Since ICS doubled my money (Return On Equity = 100%) and ICS have already proven their worth, I would gladly agree to open another shop and earn another 100% on that
3) ICS has a cool project that'll return 100%, but that project needs $50 only. So, ICS keeps $50 for that project (I expect to earn 100% on that) and pay the other $50 as Dividend
If you are a Microsoft, or Berkshire, or Intel or Apple or Google. I don't want you to return the money as dividends(Well Microsoft have ran out of cool projects and hence they are giving back the money), but keep doing the great stuff and earn more money for me
OTOH, if you are a GM, or Ford. I know from your past history and your conditions, you will not put my money in good projects, so I ask you to please return all the earnings in the form of dividends
Bottomline, if your money is handled by brilliant managers who will give you fantastic ROE ala Buffett, I don't want any dividends but please keep the money and grow it for me. In fact, BRK.A has never paid any dividends
Sure taxes help, but ROE trumps any Tax benefits
PS: 99% of clueless idiots running shady web-sites still think Stock prices are affected by Supply and Demand like commodities (true in a short time frame). But, in the long run, it is determined by ROE and its underlying Future Earnings Power
i.e BRK.A stock price went from $10 to $140,000 not because there is a huge demand of BRK.A stock, but because Buffett kept earning 25-30% Year after Year on the initial $10 you paid and the market price reflects that
Stock Price Exercise Problem
At Year 1, two shares of ICS was worth $100. i.e on an open market it would trade at $50
At the end of Year 2, if market thinks that ICS will grow 100% for the next 5 years and settle at a steady 12-15% Earnings Growth, by Discounted Cash Flow (DCF) analysis, its share price will trade around $1250
At the end of Year 3, it comes up and says it grew only 80%, the market will quickly adjust the stock price to around $800.
* Clueless idiots running shady web-sites at this point will scream,
"ICS grew by an outstanding 80%, yet George Bush and his oil buddies manipulated its share price to make it crash to $800!!!!!." They'll also scream 'Buy Buy' because the fundamentals of ICS hasn't changed
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