Methods to Value Stocks Without Dividend Payments

Valuing stocks without dividends involves alternative metrics, making it a practical approach even for non-dividend stocks. While dividends provide direct income, non-dividend stocks grow shareholder value through earnings and capital gains.

Understanding the Price-to-Earnings (P/E) Ratio for Non-Dividend Stocks

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.

Evaluating Stock Value through 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.

Using Book Value to Assess Stocks Without Dividends

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.

Why Invest in Non-Dividend Stocks?

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.