Why Meta's dividend is so valuable
Meta stock hit a high above $485 per share on Friday. That's a jump of more than 23% from where it closed on Thursday before the company reported earnings and announced its first-ever dividend.
Why it matters: Dividends are a form of financial engineering. They don't change anything fundamental about a company's size or profitability — and yet they can have an enormous effect on its valuation.
The big picture: Naively, when you own a share of a company, the idea is that you share in its profits. If there are a million shares and the company makes a billion dollars, then you are owed $1,000.
- On some level, the whole point of owning a stock is to be able to share in the company's profits. If you can't do that — if you can't take those profits to the bank — then stock ownership itself becomes a kind of postmodern and abstracted form of speculative finance.
Between the lines: In practice, companies don't dividend all of their profits to shareholders. They like to retain some for working capital, just for starters.
- A dividend is also a signaling mechanism — it's a way for a company to indicate to investors that it will be able to maintain its profits at or above the dividend level in perpetuity.
- Because of the convention that companies only cut their dividend when times are unexpectedly tough, investors value stocks on the basis of their dividend yield — essentially treating the dividend as a predicable, almost bond-like, coupon payment.
Be smart: For these reasons, profits that become dividends are treated not as the kind of risky cashflows you might expect from the company portrayed in "The Social Network" but rather something much more mature, and much more likely to continue to survive for many decades into the future.
- A company capable of paying out such cash flows is therefore considered less risky — and lower risk, in finance, means a higher up-front price.
The other side: To truly understand why investors love dividends so much, despite the fact that they have to pay a 20% tax on them, it's worth looking at the two big counterexamples — the two companies that have never paid a dividend despite being hugely and consistently profitable.
- Berkshire Hathaway isn't a company so much as it's an investment firm. Its shareholders don't want Warren Buffett to share his profits with them: Rather, they want him to invest those profits on their behalf since he's a better investor than they are.
- Amazon, similarly, has shown an ability to get well above-market returns by investing in AWS and other products like Prime. Were it to declare a dividend, that would be an admission that it has run out of profitable ideas to invest in.
The bottom line: Meta's big idea, when it came to finding something to invest its enormous profits into, was a vague and unconvincing vision of the metaverse. It's hardly surprising that investors would rather just take the cash.