A: When you own stock in a company, you own part of that company. When the company earns money, part of that profit is supposed to belong to you, the investors.
But you’re right. Investors usually get back just a fraction of the money companies make in a form of dividends, or periodic cash payments made from the company’s coffers. And some highly profitable companies, like Apple (AAPL), don’t pay a dividend at all.
The disconnect between what companies earn and what they pay out to investors can be pretty significant. Currently, the Standard Poor’s 500 has a P-E ratio of 13, meaning that stocks are trading for 13 times what the companies have earned over the past four quarters. If you flip that ratio over, you see that currently, companies are paying 7.6 cents for every $1 in stock price, or an earnings yield of 7.6%.
Meanwhile, the SP 500 is paying much less than that to investors. Stocks have a dividend yield of just 2%, which is the percentage of cash paid back to shareholders. You can also examine this same measurement using companies profit relative to all the money invested in the business, called return on assets. And the result is the same. Companies aren’t paying out nearly what they earn in profit.
Why is this happening? There are several reasons. First of all, companies are not required to pay profits back to investors. They may, and do, retain earnings. Part of that is prudent. After all, just a few years ago, companies found themselves unable to borrow and even giant companies like General Electric (GE) had to borrow money from investors at less-than-flattering terms.
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Yet, the level of hoarding cash has reached levels never before seen. Coming off the second quarter, which set a record for corporate profit, non-financial companies in the SP 500 amassed $976.0 billion in cash, the highest level on record, says Standard Poor’s Capital IQ.
Companies also hold onto cash so they can fund expansion and research and development in the future. And certainly, having financial resources to plan future growth is critical to a company’s long-term success and survival. “These companies have shareholders and board members thinking they can do better with the money than returning it,” says Robert Maltbie of Singular Research. And in some cases, when companies are growing, that may be the case, especially in an age where savings accounts yield 1% a year in interest, if you’re lucky. Dividends, which use cash, are up 12.7% over the past twelve months, yet that’s still outpaced by 18.9% profit growth during that time.
But increasingly, more investors are saying enough is enough and calling on companies to start returning cash to them. Companies are starting to respond. During the third quarter, 350 companies of the 7,000 tracked by SP boosted their dividend. Dividend payments are expected to rise 14.5% this year, accounting for an increase to money paid to investors of $39.7 billion.
Still, many companies can easily afford to increase their dividend payments to investors even faster, Maltbie says. “Shareholders need to pound the table and say to increase those dividends,” he says.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz