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For example in the case of Tesla, they always have a net loss in their operating income, but still their market value keeps increasing. What do the shareholders get as dividend?

Do shareholders get any dividends at all?

As Tesla is a zero dividend company, how do they keep operating for so long if their net income is negative?

Do shareholders have to pay to maintain their share of the company if Tesla is losing money?

Please explain like I'm five.

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    Tesla is a very apt example where the price rise is more on noise than on substance, which was present initially. – DumbCoder Jun 11 '18 at 12:05
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In simple terms, the value of a stock represents the total value of:

  1. Adding up the assets (the things it owns)
  2. Subtracting the liabilities (the things it owes)
  3. Adding the present value of all the predicted future income streams. Present value means that you look at all the future years' predicted income, and discount it to make up for the fact that you have to wait to receive it (money tomorrow is less valuable than money today).

When you own a share, you own a piece of the company, so you are entitled to a piece of all of the assets once the liabilities are paid off (in the event of a liquidation) as well as the future income streams.

When thinking about dividends, it may be helpful to think of an analogy to having a bank account that pays interest. Imagine that in January 2018 your bank balance was $100 and the bank pays 12% interest per year (just to make the maths simple). In February 2018 you have earned $1 interest. If you withdraw the $1 from the account you have $100 in the account + $1 cash = $101. If you don't withdraw the $1 then you have $101 in the account. Either way, you have $101.

In this analogy, the bank account represents a company in which you own all the shares, and the withdrawing of the $1 represents getting paid a dividend.

How does a company have a net loss in their income statement, but their stock market value still rises?

There can be many reasons why a company can announce a loss and the share price still goes up. E.g. (1) the market had been expecting a big loss but the announced loss was smaller than that (2) the market expects that there will be profitable years in the future.

The determining factor in how it affects the share price is that after you have added up all of the present values of future income streams (including losses) do you get a positive value or a negative value?

Imagine a simple example where a company makes a loss of $10 this year, but you expect that there will be a $5 loss next year, followed by a $20 profit the year after. Ignoring the present value aspect for now, it should be apparent that you will end up with an overall profit of $5 over a three year period, and so you don't care about the incurred loss this year and next. The share price reflects the fact that you will make that $5 if you wait.

Do shareholders get any dividends at all?

Dividends can only be be paid out of profits. But that also includes accrued profits from previous years that weren't paid out back then. Also note that any profits that are not paid out as dividends are retained by the company and become part of its assets, thus increasing the share price. So a shareholder benefits from profits whether or not a company pays out dividends (think about the bank account analogy).

Depending on the company's finances and future prospects, it may be preferred or not preferred to pay out dividends. Retaining them means it can use the money to invest further, which might result in even bigger future profits than if it had paid out the dividends.

Think about the bank account again. If you leave the $1 in there, then you will earn 12% on that $1 as well as the original $100 (compound interest). On the other hand, perhaps the account has a cap of $100 after which it pays no interest (analogous with a company which can't expand any further). Then you might be better off taking the $1 and finding other ways to invest it.

As Tesla is a zero dividend company, how do they keep operating for so long if their net income is negative?

By funding their losses through:

  1. Investment. People invest because they expect that a profit will be made by Tesla at some point in the future, and that this will be make up for the losses incurred in the meantime.
  2. Loans - people who are prepared to lend money to the company and are confident they will get it back with interest. The more likely it is that the company will fail, the more interest they will charge to make up for the risk.

Do shareholders have to pay to maintain their share of the company if Tesla is losing money?

No, the whole point of a company limited by shares is to separate the owners of the company from the company itself, which is a separate legal entity. A shareholder can only lose the amount he invested to acquire the share, not anything additional.

  • 2
    Should be noted that Tesla is in no way unique, or even unusual. Most if not all startups have a period in which they have losses, as they're using the initial startup investment to get their product to market, and build market share to achieve profitability. – jamesqf Jun 11 '18 at 5:45
  • "company limited by shares" The term is "limited liability". Shares have nothing to do with it. – Acccumulation Jun 11 '18 at 18:17
  • AMZN started in 1994, went public in 1997, and first recorded a quarterly profit in Q4 2001. Its high price over that period was 54 times the IPO price, adjusted for any splits etc. – shoover Jun 11 '18 at 19:32
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    @Acccumulation "Limited liability" is the generic term to cover all types of companies where liability is limited in some way. "limited by shares" is a specific type of "limited liability" company whereby owners are limited to their investment in the shares. In the UK for example you can have a company which is "limited by guarantee" instead of by shares. Shares are the mechanism by which limited liability is achieved in publicly traded companies. – JBentley Jun 11 '18 at 20:14
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When a new company is started, its assets, aside from the persons with the great ideas, are the capital (money) that the founders contributed to the start-up. Some of the money may be used to purchase tools and other equipment to make the product, ship the product, salaries, etc.

If the idea is good and the company grows, the company needs more equipment, more money for salaries, more employees to help with manufacturing, assembly, sales and shipping. The original owners decide that they will invite new owners to invest their money, as well, in return for a share of the company and its eventual earnings. They do so by offering to sell shares of the stock in the company. This may be done privately, say offering shares to the owners’ friends and relatives, or publicly, on a stock exchange. This is known as a new offering or “going public.”

When the shares of stock are sold, the company may have now many millions of dollars in paid-in capital (money) with which to expand and, in the case of most start-ups, lose money for a few years.

As well, the start-up company may find that their need for cash to pay bills today can’t be met completely if there are no profits. The start-up company may go to a bank for a loan, often a revolving line of credit.

The start-up may sell corporate bonds. For example, the investor pays $100,000 for a ten-year 5% bond. At the end of every year, the investor receives $5,000 in interest until year ten when he receives $5,000 plus his original $100,000.

At the end of the year, when sales are tallied up, often, in start-ups, the expense of creating the product exceeds the amount collected for it; that is, there is a loss. Start-ups are typically very inefficient. They buy everything at retail, they aren’t in a position to negotiate better prices for raw materials, they have a few wrong people in the wrong place. It takes a few years for sales to grow and efficiency to reduce the cost of goods sold.

When there is a loss, the start-up can dip into paid-in capital, cash from the sale of bonds, borrow against the line of credit, or all three.

Now, why, when the company reports a loss, does the price of the stock actually go up, in some cases?

Perhaps the loss is a great deal less than predicted and investors believe that the company is about to turn the corner to profits. Perhaps the loss is only a tiny bit less than expected and the investors think that the company isn’t as bad as they thought it was and are now willing to pay a few cents a share more for a start-up with long-range promise.

Perhaps the investors listened to the chairman’s remarks at the annual meeting, either in person or by conference call, and the chairman had reassuring comments about the company’s bright future.

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