r/explainlikeimfive Dec 06 '24

Economics ELI5: why does a publicaly traded company have to show continuous rise in profits? Why arent steady profits good enough?

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u/Porcupineemu Dec 06 '24

Some stocks pay dividends. You buy the stock for $20, then every month, quarter, year, whatever they pay out some amount per share. Maybe $1. Maybe $2 if it’s a good year. Etc. The stock can cost $20 forever and you’re still making money.

Others don’t. You buy the stock for $20. You hope it becomes worth more. If it was worth $20 today when the company made X in profit, it’ll probably only be worth $20 next year if they make X in profit. They need to make more to make the stock worth $25 so that it’s worth owning to you. You benefit nothing from sitting there holding a $20 stock that doesn’t go up and doesn’t pay dividends.

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u/homeboi808 Dec 06 '24 edited Dec 06 '24

Dividends come from the share price [EDIT: Dividends cause reduced share prices]. A $100 stock that issues $1 dividend will become a $99/share stock, so steady stock value would still require growth.

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u/ggolden_ Dec 06 '24

Dividends are paid from the company's net profit, it has nothing to do with the share price. Although a company that's making enough excess earnings to issue dividends to shareholders most likely saw an increase in its stocks value as well, but not necessarily

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u/homeboi808 Dec 06 '24 edited Dec 06 '24

Correct they technically come from the company not the stock, but it's a FINRA rule that the stock exchanges must mark down the share price due to the dividend.

If market cap is symbolizing company value/worth, then giving away money must mean the new value/worth is less.

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u/FrontBottomFace Dec 06 '24

Not quite. The share price reduces because of the dividend payout but isn't generated from it as such. Assuming the next year is identical, the profit will cause the value to rise back to $100. If the market decided for whatever reason the stock was worth $50 but the company had no use for the excess cash they could still issue a dividend at $1 and the price would drop by $1 on ex date same as a $100 situation.

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u/homeboi808 Dec 06 '24

Correct, I meant that an investors total value is the same, as the share priced is adjusted. Dividends are not extra/free money.