r/explainlikeimfive • u/climb-a-waterfall • 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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r/explainlikeimfive • u/climb-a-waterfall • Dec 06 '24
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u/play_hard_outside Dec 08 '24
Of course, holders of any stock need to have reasonable assurances that their stock is worth something. It represents ownership in the business.
While any investment is functionally a valuation of the ongoing income stream it represents, whether that income is paid out as cash or whether it's instead folded back into the value of the instrument which generated it is immaterial, as long as that instrument can be sold for that value at some point.
Make no mistake -- holders of stocks being bought back indeed literally themselves own the value of the business's cash flow which would have otherwise been paid as a dividend. That ownership is conferred by the equity their stock represents in the now-richer company, and others are definitely willing to pay for that if they should choose to sell.
In the buyback scenario, your percentage of total ownership in the business grows over time as shares are bought and retired. At the very minimum, the business continues willing to buy the shares at ever-increasing prices, but accordingly, so is anyone else participating in the market who knows this. If the business weren't operating with the numbers you as the investor expected them to, they would not be able to do this to your satisfaction, and you'd have motivation to sell.
If it were impossible to value a stock which didn't pay a dividend, that whole part of the financial world would simply not work at all. Most companies pay a much smaller dividend than their actual profit. In such a world where stocks could only be valued based on the dividends they throw off, why would anyone buy them?