TheShareholder

Own Stuff

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The Green Bay Packers annual shareholder meeting is this week on July 24. The team’s shareowner structure makes it much more exciting to be a Packers fan, and shares are generally in high demand among those in Wisconsin. Unlike many football teams, the Packers are run as a non-profit, so no dividends are paid to owners. Link to meeting details.

The Green Bay Packers annual shareholder meeting is this week on July 24. The team’s shareowner structure makes it much more exciting to be a Packers fan, and shares are generally in high demand among those in Wisconsin. Unlike many football teams, the Packers are run as a non-profit, so no dividends are paid to owners. Link to meeting details.

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Why Are Dividends Often Less Than Profits?

We’ve established that owning a stock is owning part of a business. Hopefully the business is profitable and able to return some cash to you. Every year the business reports how much profit it made for you, the owner.

As an example, say you own one share of Wal-Mart Stores. For the year ending January 31, 2012 (yes, Wal-Mart operates on a weird calendar), the business reported a profit of $4.52 per share. That’s great. As an owner, you head down to your local Wal-Mart ready to spend that $4.52.  You select a $4 bottle of sunscreen and confidently head to the checkout line, dividend check in hand.

The cashier gives you a funny look (she’s supposed to smile) as you present the check as payment and tells you that you are short the required amount. Even though your share of Wal-Mart produced profits of $4.52, Wal-Mart only paid $1.46 of those earnings to its shareholders. What happened to the other $3.06?

There are many reasons why a business may choose to pay a dividend that is less than its profits. The business may want to use its earnings to expand if it judges business prospects to be favorable in the future. The business may want to hold onto its earnings to protect itself from losses if conditions are expected to deteriorate. Perhaps the earnings are to be used to pay down debt the company incurred long ago, saving money in the future by reducing interest payments. The business may find that it is more tax efficient for owners to return cash by buying back its shares rather than writing dividend checks. Some companies want investors to have confidence in the future level of dividends, and consciously make sure not to pay dividends at a level that would have to be cut if a difficult environment appears. Often it is a combination of several of these reasons that prompt a payout that is less than earnings.

One of Wal-Mart’s primary uses of your earnings in 2011 was to increase your ownership of the company. At the start of the year, you shared your ownership with 3.86 billion other shares of Wal-Mart in existence. Wal-Mart spent $6.3 billion of its profits to buy back over 115 million shares. Your share of this buyback represents $1.66 of your profits.  At the end of the year, there were only 3.74 billion shares of Wal-Mart in the world. By spending $1.66 of your profits, Wal-Mart increased your ownership of the business and its future profits by 3%.

Wal-Mart used the remainder of its profits last year to expand its business. During 2011, Wal-Mart increased its number of stores from 8,970 to 10,130. Opening 1,160 stores in a single year (one every eight hours) costs a lot of money, but hopefully increases profits in future years. Expenditures to grow its business were $13.5 billion in 2011. In addition to opening new stores, Wal-Mart used cash to purchase three existing businesses. The company purchased 147 grocery stores from Netto in the United Kingdom, just over half of South Africa’s largest retailer Massmart, and a little over a third of China’s Trust-Mart.

Summary
    $1.46 paid to you
    $1.66 used to buy back stock
    $1.30 used to partially fund expansion of Wal-Mart’s business
    $4.52 Total profits for the year

Just like you are hopefully doing with your own income, Wal-Mart spent some of the profits and used the rest to invest for a better future.

Disclaimer

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What would it look like if you had purchased Caterpillar the day before the 1973-1974 stock market selloff began? Reinvesting dividends sure helped.

What would it look like if you had purchased Caterpillar the day before the 1973-1974 stock market selloff began? Reinvesting dividends sure helped.