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I'm struggling to understand the core reason to invest in stocks as a minority shareholder. Majority shareholding makes more sense as you effectively control the company, so you can pay yourself dividends or even sell the entire company at will. You can guarantee your own payback.

However, as a minority shareholder, you don't get to make any of these decisions. You're basically just hoping to eventually, some day get paid, if the majority holders decide so.

Why do so many investors agree to pay now huge sums of money (trillions in total) for something that may eventually pay dividends, and even in the best case, these dividends are only a fraction of the price you paid to acquire these stocks?

The average annual dividend rate for the US stock market is 2%. That means if you bought 100 million worth of shares, you'd have to wait 50 years to recover your investment.

Of course, the most probable way you'd eventually get liquidity for these shares is by selling them to some other starry-eyed investor - which makes the whole thing seem like a giant Ponzi scheme.

Given all that, it's unclear to me why the public is willing to spend so much money to acquire minority shares in companies.

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    That’s 2% dividends on the current value of your investment— if the stock appreciates in value you’ll get your investment capital back sooner than 50 years. – Dugan Nov 25 '19 at 0:30
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    And if you reinvest your dividends and the stock appreciates in value, you’ll get your investment capital back even sooner – Bob Baerker Nov 25 '19 at 1:40
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    There's a flawed premise in your question: stock values are based in no small part on the actual profits and assets of the underlying company. I'm not saying that stocks never operate like a Ponzi scheme as they frequently do, but it's fairly transparent when this happens: P/E ratio is more-or-less a measure of what degree the price has diverged (e.g. from a sharp increase in demand) from the underlying physical reality. People buy minority stakes in companies at least in part to capture the actual growth of that company. – Jared Smith Nov 25 '19 at 11:15
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    No one person pays trillions (of dollars, anyway) for any stake in a single company. A small fraction of that would buy a controlling interest in most companies. You seem to be aggregating all investors (there are millions of them) into one entity that is investing in every company. – chepner Nov 25 '19 at 13:55
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    @GlenYates If you don't reinvest, it will indeed take 50 years to recover the nominal investment which, by then would be worth much less than it is now. – JimmyJames Nov 25 '19 at 17:36

10 Answers 10

36

Say you buy 25% of a corn field, and the other 75% is owned by others that decide how to operate the whole field (for this metaphor, assume the shares of the corn field are highly liquid and can be traded at "fair" value at any time). Every year, that field produces corn that is then sold for a profit. The majority owner can do two things with those profits: distribute them to the owners (3 parts to them and 1 part to you) or use them to grow the field. They choose to use it to grow the field. They can invest in the field by either buying more land on which to plant corn, more equipment, or more profitable seed. Next year that field increases its yield (and its profits) by 10%. The owners decide to invest in the field again, growing the yield and profits another 10%. it now makes 21% more profits than when you bought a quarter of it.

You tell me - is your 25% of that field worth more than when you bought it? At some point, there will be no more ways to grow the field, and so the best use of the profits is to distribute them so that the owners can invest it in other ways. Or, someone may be willing to buy your part of the field, which should be worth about 20% more than when you bought it.

Paying dividends is not always the best way to get part of your investment back. You're effectively "selling" part of your ownership to yourself by removing cash from the value of the company and putting it into your bank account. If the company can use that money to grow and increase the size of the field, on paper your investment has grown.

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    This is a good explanation. One question though: can the majority shareholders dilute my ownership of the field? For example, if there are currently 100 stocks of the field, can the majority holders decide to issue 100 more shares, give 75 to themselves (so they retain 150/200 i.e. the same 3/4 ownership stake) while selling the other 25 to the public so my minority 25/100 become 25/200, i.e. lose half their value? – Jin Long Nov 25 '19 at 2:20
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    That depends on the corporate bylaws, which are the rules under which it was formed. Typically, all the current owners have a right of first refusal, so that the minority owner could buy some shares. More importantly, while your share of the corporation would have decreased, the value of the shares would stay the same because the infusion of new cash means that the corporation is now worth more. – RonJohn Nov 25 '19 at 2:35
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    @JinLong "can the majority holders decide to issue 100 more shares, give 75 to themselves (so they retain 150/200 i.e. the same 3/4 ownership stake) while selling the other 25 to the public" -- no. This would be illegal looting of the company. If the new shares are a "stock dividend" or "stock split" to existing shareholders, then the majority gets 75 and you get 25. If the new shares are a "secondary offering" to the public, then people can bid on them but no one gets them for free, and you now "own" 12.5% of both the existing company assets and the cash proceeds from the shares. – nanoman Nov 25 '19 at 4:56
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    The important part is bylaws and government laws, which should prevent major shareholders from cheating the minority shareholders. Publicly traded companies are usually vetted to make sure, their bylaws do not have any loopholes and major shareholders operate in good faith, so minority investors will share in the profits. – Falco Nov 25 '19 at 10:01
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    @JinLong In that scenario the shares would be sold, so the cash value they received for the stock would be added to the company's value – D Stanley Nov 25 '19 at 13:01
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Why do so many investors agree to pay now huge sums of money (trillions in total) for something that may eventually pay dividends, and even in the best case, these dividends are typically only a fraction of the price you paid to acquire these stocks?

The average annual dividend rate for the US stock market is 2%. That means if you bought 100 million worth of shares, you'd have to wait 50 years to recover your investment.

I challenge your assertions that:

  1. people buy stocks only for dividends, and
  2. that it takes 50 years to get their investment back.

That it because:

  1. a big portion of wealth growth (even when purchasing "dividend" stocks) is asset appreciation, and
  2. you still own the actual asset (the shares of stock). Worst case scenario is that it goes bankrupt or you buy at the peak of a bubble.

Bottom line: your concept of why people buy stock is fundamentally in error.

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    What other payback do people get out of stocks, besides dividends? If the only other payback is that someone might buy the shares for the same price or more, how is that different from a pyramid scheme in which the only value of the underlying asset is the hope that someone else will come in and buy you out for more than you paid to get in? – Jin Long Nov 24 '19 at 23:28
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    "how is that different from a pyramid scheme"? Share price rises when (there is an expectation that) the value of the underlying asset -- the company -- grows through increased sales. That's not a pyramid scheme. But sometimes it's a bubble. – RonJohn Nov 24 '19 at 23:34
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    "if I can't ... sell it or get any liquidity out of it"? Was privately owned snuck into your question somewhere? Because "unless the majority stockholders decide so" has no bearing on when/if I want to sell my publicly owned stock. – RonJohn Nov 24 '19 at 23:39
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    @BobBaerker I always use poker as my conceptual model of a zero-sum game - if I'm winning chips, it has to come from someone else's loss. The stock market is like a poker game where players periodically get new chips for free - the value of their stack grows over time (i.e. the stock goes up in value), meaning that you can make money without anyone else having to lose. – Nuclear Wang Nov 25 '19 at 14:51
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    @JinLong "the only value of the asset is that someone might buy it" - You've pretty much nailed the definition of "value" right there. The only value of a bar of gold, is that someone may buy it. – Glen Yates Nov 25 '19 at 16:38
6

As I wrote in another answer, minority shareholders have

the right to resell their shares to another investor (e.g., one who may be accumulating a controlling stake in the company). This works out so that shares are generally valued as if they were an entitlement to profits, because in the long run this is the basis of their value.

That is, if smaller investors were not willing to bid up a stock to a fair price reflecting the value of the company, then a big investor would buy up the majority of the shares at the low price and then make a big profit by controlling the company. This does sometimes happen (e.g., an undervalued company goes private). But generally all investors understand that the potential of a buyout is a concrete reason that each share is worth something real, regardless of the company's current dividend policy.

EDIT: A controlling shareholder is motivated to maximize the long-term value of the company, and any other shareholders, however small, are along for the ride in the same boat. Whoever has the most strategic, optimized, long-term plan for the business is likely to make the highest bid in the stock market and accumulate more of the company. If remaining minority shareholders don't value the stock as highly, the majority shareholder will be happy to take it off their hands and increase their own stake.

In particular, it might indeed be optimal to pay little or no dividends for a long time so the company can grow faster, and then start bigger payouts sometime in the future. (Importantly, these dividends will flow to all shareholders proportionally, so even a small investor will see the same return.) Small investors who want dividends now might not like this, but the key is that less patient investors can sell to more patient investors and get the rewards of a bright long-term future in the form of a higher stock value today. And since everyone knows this, stocks are valued as if all shareholders are patient.

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  • My interest is mostly in minority stock holders, since majority stockholders clearly have far more control to get liquidity for their holdings. I'm wondering what happens if the majority shareholders decide not to pay dividends at all? They don't have to, and I can imagine many scenarios in which they'd prefer to pay nothing, to the detriment of minority stockholders. – Jin Long Nov 25 '19 at 0:03
  • There is no guarantee of either dividends or appreciation, no - that uncertainty is a key characteristic of equity investment. You get higher average returns but a small risk of getting less or nothing. If you want contractual guarantees look at the bond market instead. – pjc50 Nov 25 '19 at 10:57
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    @JinLong, when they decide to not pay any dividend to minority shareholders, they do not pay any divident to any shareholder. As a minority shareholder, you are not treated differently than the majority one (at least for dividend payements...). Besides, if they do not pay dividends to shareholders, it means in essence they pay the dividends to the company itself, increasing its value, so the price of your minority stake increases by the same % as the majority holders. – Hoki Nov 25 '19 at 14:41
5

Endowment manager here.

Investing works. Really.

If you think it doesn't, that's a knowledge gap. We'll close it. Now, investments earn money one of three ways: interest (on investments such as bonds or loans), dividends (on stocks), and capital gains (the increased value of the thing.) If Ford stock went from $8.10 to $8.80 in the last year, that 70 cents is capital gains.

Endowments are large buckets of money that are invested to produce "income forever". They support charitable causes like university professorships, soup kitchens, you name it. The endowment is invested to provide 4-7% a year while keeping up with inflation. Really.

Endowments typically have an asset mix of about 80% stocks and 20% bond-like things. How does this work? How is this wise? Stocks have the best long-term growth of any investment. But a high-growth investment comes with high volatility - sharp up/down movements in the short term. The muggles call this "risk"; endowment managers don't care, because their planning horizon is well beyond 30 years -- and over 30 years, volatility averages out. Over such long horizons, the stock market always performs well.

That is because the stock market is capturing the industrial output of the country/world, which is getting better and better in the long run. When you buy a high-profit iPhone, where does that profit go? Into AAPL stock, either as dividends or capital gains.

Consider dividends and capital gains to be equivalent

Our grandfathers expected that bought solid "blue-chip" companies that would last forever, like Sears Roebuck, US Steel or the Pennsylvania Rail Road. They paid high dividends, and that's how you took profits, and they would issue dividends even if it hurt the business' capitalization.

Today, issuing dividends has gone out of vogue. Now, the companies keep the profits, which causes it to increase stock value - i.e. it becomes a capital gain. For one thing, this works better for investors from a tax perspective: you choose when you take your gains, instead of having the gains (and taxes) forced upon you by a dividend issue. That is why average dividends are only 2% - most companies have quit doing them.

Before 2007, endowment law said you couldn't spend the originally donated dollar amount, but you always could spend interest and dividends. Which is a throwback to grandpa thinking. So managers chose stocks that paid high dividends, even if that was a poor investment overall. The bucket of money suffered.

  • Ford (F) paying 6.75% dividend but losing 4% capital loss == 2.75%
  • Google (GOOGL) paying 0% dividend but 24% capital gain = 24%

(These are extreme examples, but it makes the point. Optimizing for dividends isn't a great strategy.)

So endowment law was rewritten. Now, interest, dividends and capital gains are treated the same: folded back into the endowment's capital. Then you withdraw 4-7% only. Now it behooves the fund to buy high-growth (but high-volatility) stocks like GOOGL. After all, the ultimate goal is to grow the fund long-term.

Look at dividends and capital gains together

So this gets a little tricky. You can look at GOOGL's chart and instantly see the growth, because it's all in the capital gains. For Ford, its value appears to be backsliding in recent years, but that would ignore the substantial dividend it's been paying and you have to include that.

Now you may say "Well, a dividend is a payment to me; I can spend it! A capital gain only exists "on paper"/in theory, it buys me nothing." Well, yes, but you can pay yourself a "dividend" from a stock like GOOG by selling a small part of your holding. That's exactly what the endowment does; if it decides to withdraw 6% but only 3% of that is actually sitting in cash from dividends, then they sell 3% of the stocks. This is routine, and you'd be buying/selling stocks anyway as you periodically rebalance the portfolio.

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  • My key difficulty was understanding the benefits of stock ownership. Owning bonds provides a clear benefit: guaranteed regular cashflows of specified size. Stocks don't have such clear benefits. Even the most successful corporations aren't obliged to pay out dividends at any point. GOOG is among the most successful companies in human history, yet owning shares of it is by itself worthless: the owner can only get value by selling their stake to the next fool. I was baffled when I realized people paying are vast sums to own stocks when that ownerhsip by itself provides them no benefits. – Jin Long Nov 25 '19 at 17:00
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    @JinLong Since you feel that way, sell me your GOOG shares for $1/share. I'm a collector, I like weird stuff like that. And I'm doing you a solid -- that's real cash money you can actually spend. Seriously though, yeah. The whole concept of stocks is counterintuitive. It took me awhile to figure it out, and it was like "OMG!" You seem very fixed in your beliefs, which is a mistake - the sooner you figure it out, the better retirement you'll have. – Harper - Reinstate Monica Nov 25 '19 at 17:21
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    Thank you for your offer. Far be it from me to unload such worthless assets on an unwary stranger making such kind suggestions purely out of their politeness and altruism. My GOOG holdings are my cross and I shall bear them with appropriate self-sacrifice. – Jin Long Nov 25 '19 at 17:21
  • Kidding aside, I do follow expert advice, even when I don't understand it. My portfolio is currently 90% stocks. I recall your excellent answer about being able to perpetually generate 1/20 of your portfolio, as long as it's sufficiently invested in stocks, and if anything, I may have taken that approach too aggressively, and should be asking you if I am excessively invested in stocks with them composing 90% of my portfolio. – Jin Long Nov 25 '19 at 17:35
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    @JinLong I for one don't think so. The 20-ish percent of endowments that's typically in low-growth "safe" investments is there to make the more skittish board members feel comfortable. If your planning horizon is out 30 years, go all-in. I do. – Harper - Reinstate Monica Nov 25 '19 at 18:30
3

You have several good answers already, but I feel there are two important factors worth mentioning, which haven't been brought up yet.

Firstly, your assertion about investing as a majority shareholder in a single company seems to be based on this belief:

You can guarantee your own payback.

That's simply not true, in nearly any kind of investment. Because of risk.

Investing involves a basic trade-off - the potential for income, but also the potential for loss. It is simply not possible, even as a majority stakeholder, to actually guarantee your own payback. Any company can fail, and any ownership in that company can suddenly become worth less (or nothing).

To a degree, risk and potential reward balance themselves. If we expect all companies to essentially behave similarly in the long term, becoming a majority stakeholder in one company vs a minority stakeholder in many companies may result in a similar expected outcome, but the diverse portfolio will be more stable because opposite changes in individual investments will cancel each other out. Hence, many investors choose latter simply because of that stability - they don't want to put all their eggs in one basket.

The second component is essentially investment strategy based on investor expertise or skill (or perception thereof). Investing as a majority shareholder in a single company is essentially based on a belief that you know enough about that industry to outperform other people. You believe that you are a winner in that market. Meanwhile, investing in a diverse portfolio of companies, as a minority stakeholder, is essentially based on a belief that you are good at picking winners. Some people are good in a primary role, others are good in a secondary role - supporting a cast of primary roles. Arguably, there are tertiary (and beyond) roles, as well - people buying mutual funds are essentially doing so because they believe they are better at picking people who pick people who pick winners in specific markets, and so on.

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    and fund of funds buyers who essentially believe they are better at picking people who pick people who pick people who pick winners, haha! – Michael Nov 25 '19 at 23:55
  • It starts feeling silly really quick when you say it out loud, doesn't it? – dwizum Nov 26 '19 at 13:50
0

When it comes to dividends, a majority shareholder has no advantage over minority shareholders. Each one receives the same percentage of their investment when a dividend is paid.

If a stock pays a 2% annual dividend and there is no share price appreciation then yes, you'd have to wait 50 years to recover your investment. At the same time, share value would go to zero and that doesn't happen because shareholders are "willing to bid up a stock to a fair price reflecting the value of the company" (attribution to @nanoman).

I don't agree that stocks are a Ponzi Scheme because a Ponzi Scheme is a fraudulent operation where the operator provides a return to earlier investors from new investors, without ownership of the underlying securities. While doing this, the perpetrator siphons off large sums of money for his own benefit.

But if we're going down this road, if anything, I'd compare stock ownership to the Greater Fool Theory where a price is justified because of the belief that someone else will be willing to pay an even higher price for the security.

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  • "if anything, I'd compare stock ownership to the Greater Fool Theory where a price is justified because of the belief that someone else will be willing to pay an even higher price for the security." Is that much better? – Jin Long Nov 25 '19 at 1:05
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    @Jin Long - Yes, the GFT is far better because it's not fraud. If we're going to play the What's Similar To This Game, the GFT is a bit like any business today. You buy something with the hope that you can sell it for more. In some cases, it doesn't work forever (8 track tapes, VCRs, etc.). Ponzi is like buying an 8x11 piece of blank white paper based on the promise that it's worth $10 now and will be worth more in short order. – Bob Baerker Nov 25 '19 at 1:32
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    In the short term GFT comparison is somewhat valid, the fact that -- over time -- corporate incomes rise means that shares are actually worth more means that later buyers are not Greater Fools. Irrational exuberance (aka "bubbles") are when you're hoping for a Fool. – RonJohn Nov 25 '19 at 2:40
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you're right, you aren't missing anything. The whole concept of a market for company stock is fairly new and coincidental.

Ownership of a company is merely a conduit for proportional sharing in the common enterprises' profits. They are holes in the company treasury directly to you, and any transfer through these holes to you are taxed differently than other transfers. They are specifically called dividends.

These contracts of ownership are arbitrary. And such the idea of selling these rights in a standardized way took a lot of collaboration and human ingenuity, and this was a prerequisite to having a market where people can very quickly buy and sell these rights for different common enterprises.

This doesn't change the purpose of these shares of being conduits.

The coincidental nature of this active buying and selling is that people buy these rights for prices that are much higher than the company itself had valued the shares at. The company originally made an attractive investment where people would get above average returns - from the conduits alone, via dividends. The people resold those rights to others at higher and higher prices, while the amount of the dividends didn't change. This means the % dividend to your amount of investment keeps getting smaller and smaller, pretty much until average returns in line with the market are reached. Basically until investors - just like you - look at the expected returns and walk away, just like you are considering to do.

Now that we got the main concept out of the way, lets look at what's actually happened:

Company don't issue dividends for a very long time, or ever. It takes an activist majority investor to force a company to issue dividends, and only if it doesn't ruin the finances of the company to do so because then the majority investor will potentially lose more from the depreciating price of the stock.

So yes, you then become left with trading the "rights to dividends", the conduits I was referring to, the price of the shares itself.

All of this is happening while there are other markets to invest in. The robustness and popularity of the stock market doesn't mean it has anything that requires your attention. Other markets have different rules, different books, different financial gurus, but they are around. Or you just remain content trading the price of the shares themselves.

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  • New? The Dutch East Indies Company was publicly traded, and was centuries ago. – MSalters Nov 26 '19 at 10:18
  • @MSalters the efficiencies are improving and making the more attractive, lowly rated corporate bonds are publicly traded as well, the public interest in that market is limited by poor infrastructure and non-standardization – CQM Nov 27 '19 at 6:46
-1

Your argument is self-defeating. It boils down to this:

  1. As a majority shareholder, you can sell the company outright to recover your investment. This is a legitimate investment transaction.
  2. As a minority shareholder, disregarding dividends, the only way to recover your investment is to sell your shares to some other "starry-eyed investor" looking to reap big profits. This transaction amounts to a "Ponzi scheme".

For some reason, we are expected to believe that the buyers in 1 are fundamentally different from the buyers in 2. That buying the entire company is legitimate, but buying another minority share is "a Ponzi scheme." Thus, we are led to conclude that buying a commodity is only legitimate when you buy most or all of it. This is a rather strange economic/ethical/philosophical position for which you have offered no justification.

When you "sell the company outright", what is the economic justification of the buyer? Why are they so excited to buy your majority shares? Aren't they in on the same "Ponzi scheme" that the minority shareholders are playing, but just for higher stakes?

Ultimately, there are only two rational reasons to buy anything:

  1. You intend to consume it
  2. You expect it to increase in value

You can't "consume" company stocks (well, you can, but I don't think they taste very good and lack nutritional value), so the only reason you would buy one is for 2, whether you are buying a single share or 90% of them or all of them. Note that Ponzi schemes fit into 2. However, what makes a Ponzi scheme illegal is fraud. Ultimately, a Ponzi scheme promises something it cannot deliver. Every prospectus you receive for a financial instrument had better include the phrase: "Past performance is no guarantee of future results." Thus, a Ponzi scheme is merely an investment with a guaranteed return.

Gold pays no dividends, yet people invest trillions in precious metals. Real estate pays no dividends (unless you count rents), nor guarantee of future value, yet in the US, real estate is worth more than 3x all equities combined. If buying companies whole is the best way to make money, why are there so many suckers in real estate?!?

Every investment is predicated on 2: the future value of the asset will be worth more than the present value. Therefore, I can recover my investment and take a profit by trading the asset with a future buyer at that future market price. It doesn't matter if the asset is a misprinted stamp, a Beanie baby, or a field of tulips. As long as someone in the future is likely to buy the asset for more than I can acquire it today, it is a potentially valuable investment vehicle. Dividends, rents, royalties, interest, etc. are just alternative ways in which the future value can be higher than the present value.

Finally, there's one glaring hole in claim 1: your ability to sell a company in no way implies your ability to reap a profit. If the company loses market share (fewer people buy its products), assets (has to sell off equipment, real estate, IP, etc. at a loss), or simply becomes unpopular among investors, it is entirely possible that at the moment you wish to liquidate your ownership, prospective buyers will only offer you pennies on the dollar for your stake. Like any investment, it is possible that you can recover nothing. Starting to sound Ponzi-like, hmmm?

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  • Actually, a third reason to buy something is "You expect to use some positive effect of posessing it." For example, I buy my dish-washer because I don't want to wash the dishes by hand, i.e. saving work. But I don't consume it (hopefully). Same for stocks – you can buy them for their dividends, even if you don't want to ever sell them again. – Paŭlo Ebermann Nov 26 '19 at 0:13
  • I lumped "use" and "consume" together. Yes, I don't expect most people to buy a car to eat it or to profit from its highly unlikely appreciation. Nor do you "consume" a luxury cruise or designer purse in the literal sense. As far as dividends go, I'm inclined to go with Harper's description as merely another kind of "increase in value" morally equivalent to capital gains. – Lawnmower Man Nov 26 '19 at 1:52
-4

Why do investors pay trillions for minority stakes in companies, when their only potential payback is modest uncertain dividends?

It's just paper.

The only reason is shared belief that someone else will want to pay for the paper in the future.

End of story.

Note that the classical answer to your question is:

If in the future some large entity, E, wants to take control of company X, then at that time, E will have to buy up a lot of the small holdings of X. This is the only sense in which paper of X has any "actual" value.

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-6

Buying 100% of one stock is not aiming at doing trading. It's aiming to manage a business.

While the stocks trading aim at doing capital gains regularly, by multiple operations.

If you don't invest for the long term, you are not waiting for dividends to come, since you will have resold much before the day of payment.

In general, you don't want to invest for dividends : Let's take a usual 2% of dividends. To get as few as $1.000 per year, you would need to block $50.000 of your cash constantly. So you cannot live on dividends except if you put many hundreds of thousands or millions. But even if you had that money, that would be a bad idea, since with leverage you can acquire bigger assets. Indeed, with $100 of shares, you only get $100 worth of assets ! So you don't go far.

Apart from that, keeping money willingly as a minority shareholder, it can be a way to store your cash in a non-taxed environment (as long as you don't withdraw your benefits, you are not taxed).

To summarize, it depends of your timeline and objective in investing, but focusing on dividends is misleading, in my humble opinon. If you do stock or options trading, you target immediate gains, or store money in a company that you are sure that it will grow later.

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