Because the money that would be paid out as dividends is instead reinvested in the company, increasing its ability to produce profits in the future. Assuming that managers can find investment opportunities that exceed the return on capital that a shareholder would otherwise get, this is a good trade.
This is a fairly big assumption. It tends to be true in younger, high growth companies, or companies where management is good at identifying other profitable markets to enter. This is why Google, Berkshire Hathaway, Apple, etc. never pay dividends, and why Microsoft didn't until recently.
Unfortunately, managers tend to be pretty poor at realizing when their market is no longer growing. So they'll think they can buy growth by acquiring companies or hiring more people, but end up destroying shareholder value when the exorbitant purchase prices don't pan out. Good for entrepreneurs, but bad for investors.
It's not as simple as "dividends = good, stock price appreciation = bad". There's been a fair amount of academic mathematical finance devoted to dividends, and it showed that investors should be ambivalent about dividend yields, as long as management was economically rational (i.e. would only undertake investments if the expected return was greater than the cost of capital). A reduced dividend just means that more money stays within the company, which increases its future value.
You're still talking about a world where dividends still exist. They're being generated & reinvested. This is in order to create more dividends in the future. Once reinvesting becomes expected, it just means that dividends aren't getting paid. We blur that issued then reinvested concept & just readjust our expectation for companies to grow.
The issue is that a situation where dividends are the norm, this keeps the system honest. Cash is harder to fake. If people own stock for dividends it's harder to get carried away.
The reality is that many companies will probably never pay dividends justifying their current valuations.
You can't just say that you've abstracted away the middle part & look at indicators of indicators of indicators forever. This isn't engineering. There is an enormous psychological element involved. You wouldn't get Uncle Khaled to invest in your shop if he visited & saw that no one walked through the door.
If you're arguing that most companies are not generating anywhere near the cash flows needed to justify their valuations, you'll find no argument from me. Even after falling 45%, S&P500 P/Es are still around 12, which implies an earnings yield of around 8% assuming earnings stayed constant. Given the historically record earnings of recent years, that seems to be on the high side of reasonable.
But if there were a company that traded at a P/E of 7-10, had no red flags like excessive debt or discrepancies between cash flow and earnings, yet paid no dividends, I'd have no qualms about investing. That actually describes Berkshire Hathaway pretty well, if its stock price were to drop a bit.
I'm arguing that it's fine to have some companies that don't pay dividends. Fine in a world where the standard is dividend paying companies. Once they become the exception, once you stop even speculating about what they would be paying if they where paying, once you start talking about, game's up. Stock becomes trading cards.
BTW, it's not just not paying. Paying 1-3% is the same sort of issue just that then it's the investors rather then the companies fault.
But then, all that says. It still works. Sort of. Baffles me.
This is a fairly big assumption. It tends to be true in younger, high growth companies, or companies where management is good at identifying other profitable markets to enter. This is why Google, Berkshire Hathaway, Apple, etc. never pay dividends, and why Microsoft didn't until recently.
Unfortunately, managers tend to be pretty poor at realizing when their market is no longer growing. So they'll think they can buy growth by acquiring companies or hiring more people, but end up destroying shareholder value when the exorbitant purchase prices don't pan out. Good for entrepreneurs, but bad for investors.
It's not as simple as "dividends = good, stock price appreciation = bad". There's been a fair amount of academic mathematical finance devoted to dividends, and it showed that investors should be ambivalent about dividend yields, as long as management was economically rational (i.e. would only undertake investments if the expected return was greater than the cost of capital). A reduced dividend just means that more money stays within the company, which increases its future value.