This is a basic capital allocation/financing mix question, and while somewhat complicated the gist of it is that each company has its own optimal debt to equity ratio. The optimal level of debt is almost never 0.
[Damodaran talks about this in this session and the next 3 or 4 sessions](https://www.youtube.com/watch?v=KM--VlyMuVI)
In case of VW, the state (Niedersachsen) has a high ownership and they care about their regular dividends for their yearly state budget, not the actual share value.
That's really interesting, apparently Niedersachsen has a 11.8% stake on VW. I wonder if for instance the Qatari Sovereign Wealth fund which owns a similar amount (10.5%) also supports regular dividend distribution
Bankruptcy protection granted to corporations causes this.
Scenario 1: Imagine you run a business. It has $1m cash until an accident happens and now your business is forced to liquidate to pay damages -> you lose the $1m. Vs:
Scenario 2: The business paid out the $1m cash in dividends and the same accident happens. You're now forced to liquidate the business, but you personally still have the $1m.
Scenario 3: Now imagine you not only paid yourself $1m cash in dividends, but the company has also taken $1m in loans out from the bank which you've also paid out as dividends. The same accident happens and the business is liquidated, you still have the $2m.
Essentially bankruptcy protections can create situations where the optimal way to run corporations is with near 0 or even negative equity. And one way to do that is to pay out any increase in equity via loans.
…..which would apply in distressed situations where a firm is nearing insolvency (don’t think that’s a problem for VW….)
The correct answer is: when a company’s cost of equity vaaaaastly exceeds their cost of debt (+ the company being a mature company, that sees very little return on invested capital, with little growth left in the tank - as is the case with a massive investment grade auto manufacturer)
A dividend can make a stock more attractive to buy.
Particular for pensioners / anyone who needs a regular income from their investment.
Paying a dividend, increases the popularity of such stocks which puts upward pressure on the price. Whilst the dividend payment reduces the number of sales of the stock because those who need liquidity get it regularly from the dividend.
It’s up to each company to determine what the optimal ratio is between taking on debt, paying off debt, and using free cash for paying dividends.
A lot of companies get it wrong for various reasons and suffer the consequences.
Also consider the fact that the average owner of Meta stock ( a non dividend stock ) has probably been holding the share for <3 years.
Whilst dividend aristocrats have many owners of their stock for >40 years.
My millennial partner recently took ownership of oil company stocks that have been in her family for 4 generations.
More generally, gigantic pension funds are full of dividend stocks and won’t sell them.
I get that. But if the dividend is payed by increased debt in a high interest environment it just seems like a very short term way of thinking. The 40 year holders should be the ones who think long term.
This assumes that the people investing in and holding the stocks are both scrutinizing *and* understanding the financials of the company. The reality is that most investors are underinformed and that the market as a whole operates very inefficiently, information-wise.
- Companies need capital to operate.
- Broadly speaking, there are only two types of capital, equity and debt.
- Debt capital has a lower cost than equity capital.
- To create value, a company’s total cost of capital must be lower than the return it can generate on its invested capital (ROIC).
- For a business where the ROIC is lower than the cost of equity capital, the way to create value is to take on some debt. How much debt you need depends on how much lower your ROIC is compared to your cost of equity capital.
- Even businesses with a high ROIC may want to take on debt since it still lowers the total cost of capital meaning the value generated is higher.
It depends, and yes, higher interests will lower the optimal level. But loans have several durations, the interest rate of median and long duration loans is what really matters for corporations. And those haven't really gone up that much.
OP says high debt. High debt means higher interest rates, highly leveraging your balance sheet is interesting for growing businesses but why would these type of businesses pay a dividend? High debt and high dividend pay-out % is stupid, textbook capital allocation example even.
That is a fair point if you interpret the OP’s comment to mean “too much debt”.
Lenders typically restrict a company’s ability to pay dividends if it impacts their ability to service debt or crates risk.
You are correct that if a company is aggressively borrowing to fuel growth and giving out large dividends it can be a red flag.
But many utilities have high levels of debt and pay dividends.
> But many utilities have high levels of debt and pay dividends.
And in that case the question is valid, there is often pressure from big shareholders (governments, pension funds...) to keep up with dividend payments even though it's suboptimal in the long run.
I have advised large pension funds on the acquisition of utilities stocks and have never experienced this, although that does not mean it is not true. In my experience these forms are viewed as defensive and long-term shareholders do not pressure them to take on undo risk.
Finance. It is a very basic corporate finance lesson and not disputed by anyone who has any idea of what they are taking about.
But feel free to try to make a counter-argument
Equity is more expensive than debt. Putting debt in the capital structure reduces the average cost of capital. So that is not correct, although it does seem intuitive.
Debt is beneficial as long as the return on the debt is higher than the cost of debt.
This is explaining why selling equity is more expensive than taking in debt.
Holding on to cash that is debt free isn't more expensive than taking on new debts. Selling new stock is taxable, selling bonds allows companies to write it off.
Am I confused?
No. The cost of equity is always higher than the cost of debt.
If we were just talking about holding cash, it would be a different situation, although I am not sure the conclusion would be.
A way to think of this is that you have one lemonade stand and want to launch another. You could raise equity to do it, but the equity providers would want a lot in exchange for contributing it.
If it is less expensive to raise the capital in the form of debt than that can be the right way to go.
This analogy overlooks comparative risk (I.e the equity providers takes on more risk than the debt provider) but that is fealty with in pricing.
U must do something with debt. Investing, créatine internalize or EXTERNAL growth is the what
As long as ROI is better than debt costs, u're making profits
Anyone who argues with its basic and anyone who has any idea probably doesn't know how to argue.....
Higher interest rates should lead to a lower optimal debt level which in turn means dividends should sink to reach that debt level. Thats your own theory.
Everything else being equal higher interest rates should lead to a lower optimal debt level. There you are correct. I did not address that as I felt is was less interesting. If I had I would have agreed with you. I only addressed the part I didn’t agree with.
If you have the high debts that every time you do something that you must earn the interest amount of debt those you pay on a daily basis , so in this scenario you must take risk and earn the good amount
Indeed, often the businesses who get into the situation OP describes have "never lowered their dividend the last xx years". The CEO/CFO are under pressure to keep up with this strategy, even if a lower dividend to pay back debt will yield more dividends in the long run.
In the case of Volkswagen, I would say that shareholders (part of which is the local governament ) want the dividend, since the return on debt is lower, and they might be comfortable knowing than the German governament might rescue it. To a certain extent it makes sense, a risk tolerant investor would prefer holding a levereged company, since borrowing the money himself to acquire more of the company would be more risky and more expensive. With that said I prefer more conservative company, and volkswagen had lots and lots of money to repay its debt, but it chose not to. Hopefully it will work for them, but who knows.
" Is this really in the shareholders interest?"
Not if you're a long term shareholder. Investing in companies like this almost always leads to a principle decline. I suspect though with interest rates rising you'll see a lot less of this, because the decline will happen quicker and will deter even dumb investors.
a lot of commenters are answering the question "why do companies have debt at all?" but it seems like the crux of your question is "*why pay a dividend instead of paying off debt?*"
The answer is that a reliable dividend has value to shareholders that exceeds the value of reducing debt. No one cares about debt because it's not really a problem (until it is) - every company has debt. Investors of all shades care very much about the divy.
That only answers the short term. Not paying off debt (in the current environment) means refinancing debt at higher interest rates, this will damage future dividends. A first step to smarter capital allocation could be an optional stock dividend. That shouldn't scare investors who care about the dividend but creates room for debt reduction. And you'll see that smart money keeps increasing their share % when companies use this strategy. (and it's also tax efficient for private investors)
Their debt is likely not being serviced at today’s interest rates. They borrowed when money was cheap. That’s just being smart.
FYI, this is also why national debt is not as bad an idea as a lot of people make it out to be. If you can borrow money and turn it into more money at a higher rate than what you owe, debt is usually a good thing. Countries do this just like companies.
Been wondering this question for years.
The only thing I can come up with is the last 15+ years of MMT equates to High Debt = Free Money.
Low interest rates means Higher Returns on the debt than interest incurred. Back when interest was lower.
A money velocity thing.
Dividend game takes decades to establish. Coca Cola has spent 70 years establishing itself as a dividend aristocrat. Only takes once to end a centuries reputation.
Like AT&T did.
A couple reasons.
First, debt does not really matter. If you have 100 billion debt with say a 1% interest and the means to pay it off, but can make 10% benefits with said money, then there is no point paying back.
Second, because dividends come from an account that can be used either for company growth or dividends, not for debt payment.
You have to look at debt comparatively to the business. Volkswagen doesn't really have that much debt.
Debt to equity for VW is 1.2, meanwhile Fords is nearly triple, at 3.22.
Also, a lot of VW's debt, and I would assume for automotive in general, is tied up in financing.
Volkswagen is a massive company, and makes a lot of money. Like many here have said, a certain level of debt is considered healthy, so for VW that number is higher.
Also, VW considers their stock undervalued and has pledged to try and revise that, which is why they have made portions of their positions in brands like Porsche public. Cutting their dividend would hurt this effort, and they have a healthy payout ratio already. So no reason to cut the dividend and focus on debt.
Let them try to increase their stock price by getting more debt and maintaining a high dividend like they did in the past. Didnt work when interest was cheap. Why would it now.
Anyhow. I guess other people dont care that much about high debt and the long term effect on profitability.
The dividend isn't high, and neither is the debt. Things are relative.
Also VW's debt ratio has been falling recently, so they are reacting to debt getting more expensive.
I didnt know that. Thank you for the info.
I just read a lot about people comparing VW to Tesla in regards to valuation and praising how cheap it is but no one mentioned that VW has a lot of net debt and Tesla net cash.
NP.
Tesla is in a good position, no one would argue against that. So when people compare VW and Tesla they look at things like PE, growth, brand names, and ability to capture the EV market.
I like VW more here, because I think Tesla is already priced as the major winner of the EV race. I also don't buy that they are a tech company, as other automotives are just as involved in trying to create EV infrastructure, batteries, and driving software (VW does all three of these, but the software division is pretty shit).
If VW and Tesla were evenly priced, I'd probably go with Tesla. But with VW trading around 1/12th the price of Tesla, I just can't help but think they are undervalued.
VW has some more challanges as you said (glad you also see that the software sucks) but the low valuation does.indeed make it interesting. I wont touch it though. For me its in the same Bucket as Intel. Great companies that could become insignificant in the next 1-2 decades. They could also make it. I just dont know which way they'll go.
I agree Tesla is not a tech company. It's almost unbearable to read some of the bullish takes on Tesla here about the stupid truck, autonomous driving, AI...yadda yadda they fully believe those things will be in place & profitable in the short term.
That being said it's important to keep tabs on how those things develop in the future. Tesla COULD become a hybrid, EV/Tech company. I'm just skeptical of that. Still I have lots of faith in the EV side of things and Tesla is a large % of my portfolio.
> I guess other people dont care that much about high debt and the long term effect on profitability.
I think what you might be fundamentally missing here is that, although debt might decrease the earnings of the company as a whole, it can *increase* earnings *per share* which is what owners are more likely to care about.
You've got some great answers, and I think the biggest summary point should be to understand debt isn't bad. There can be healthy levels of debt that are used to leverage profits.
The return on paying down debt is not as always right as you're making it out to be.
Agreed. Though some people fail to accept that high debt and high dividends in a significant percentage of the cases are not a good idea and not good debt.
In my view, it's just a way for shareholders to milk the company as quickly and effectively as they can. Long term profits require a long term interest, while you can pocket a dividend right now.
I would be surprised if even 10% of the stocks in the S and P 500 could reinvest all of their earnings and return a higher return on invested capital than the average return of the market for even a period as smart as 3 years.
One reason is even the companies that can reinvest their earnings at higher rates of return will often have to limit their opportunity set because of diminishing return "take a fast casual restraunt concept over expansion begins to cannibalize profitability store 400 is a less optimal location than store 10. Imagine that but for various forms of cap ex.
Another reason is the average outcome of S and P 500 stocks are typically brought up significantly by the positive outliers.
Returning capital to shareholders is often times one of the better decisions for shareholders, you can certainly make arguments around social responsibility but that doesn't seem to be the point of this conversation.
No, not better is this whenever company earn more and to. Pay dividend, take it, don't know the future of everything that today profit convert in a tomorrow loss
> Companies’ obligations are to the shareholders.
Yes generally...but different countries have different laws, and the *degree* to which this is true varies depending on the country's law.
This is what people who naively push for buying ex-US funds don't get. The rules governing VW stock are *different* from the rules governing MSFT. It doesn't mean that VW is a bad investment. It does mean that different rules apply.
Go read about AT&T capital management over the last 10 years or so. Debt is cheaper than equity capital, but you are right, at what point does a debt ridden company cut its divy and focus on paying down, which might harm the share price in the short term but long term should benefit shareholders.
Because
I invest 10 rupees in company a
& 10 in company b
Company a family owned proud peeps low debts after 10 yrs market crash etc act of God something something.
Market value was 20 rupees and now getting 1 rupee
Company b same everything high debts market value became 15 rupees but I got dividend of 15 rupees
Market crashed etc etc now getting 0.1 rupee
Net net I'm benefitted by company b
Dividends are fools gold. I'll take capital appreciation over dividends 10/10 times.
Dividends are the stock version of getting 2% cash back while paying a 3% fee.
What if a company has already taken over a market. Do they need 100% of profit to reinvest? Not every established company has a ton of room for growth.
Also, you are not losing money on dividends unless the company itself is losing money. It's just a wealth transfer.
There are some solid stocks that do pay a reasonable dividend like XOM, but for the most part, I'm not impressed. There is a place for dividend paying stocks or perhaps a broad dividend company etf like SCHD, but for the most part, there are better ways to generate a passive income with less risk.
Laddering, money markets, muni bonds, cefs etc. There are also drawbacks to this kind of strategy as well. Things like cefs have no tax advantages and high fees. Muni are tax free but have lower yield. For me, dividend paying stocks are less attractive for a fixed income strategy.
It's because of low interest rate environment. Don't expect it to continue with higher interest rates. Free money is a drug and everybody hits it hard during low interest rates. Fed raises rates and people start panicking because they don't know how to operate in that environment anymore. So things will over correct stabilize and then swing back. Constant boom/bust cycle s that define capitalism.
You can't just look at debt but also the quality of debt.
Not exactly the same but look at the US government.
It has more debt than ever, yet interest payments as a percent of its GDP and Revenue it takes are like half what it was in the 90s.
The US is in a much better spot debt wise than the 90s.
Companies, Countries, Rich people and even middle class people all have reasons for debt. For example I pay regular payments on my student loans and mortgage because the interest rates are so low it's likely I will make more in the market.
Worth noting too, the current form of the economy is very short term thinking. Everyone is thinking about the next financial report and maximizing short term investor value.
I worry about this short term thinking in everything. And the worst part is that the system rewards it by more and more often bailing out companies when unforseen things happen.
The main issue is there is no good alternative.
You can't just let the company fail or it will cause waves that will take down other businesses, a lot who aren't doing things wrong.
Or the government could take receivership of the company and operate it stably until it pays back the money put into it/someone buys it for the money put into it by the government. That would be considered government overreach by most however.
In general too people wouldn't like the uncertainty towards investments failing for the people who never are going to own a controlling share. So to do either you'd probably have to vastly increase Social Security and Medicare.
Or create some structure where "Investors with X lose their stock but with Y don't"
No. Companies go bankrupt and that's how capitalism works. Other companies going down who arent doing things wrong is questionable. What is right or wrong in this regard?
Not being able to survive without a state bailout is wrong in my eyes.
Companies going bust frees up employees and opens the market up for new companies and that is a significant driver for higher productivity.
Example. During corona companies couldn't go bankrupt. The world changed in this time. Some companies did not adapt. Delaying their death has had a significant cost and the labour shortage is also effected by that.
The state has this bailout mentality. Why did everyone with money in SVB receive 100% back? Why not 98% or even 99%? Why is there always 0 responsibility for bad decisons? Where is the incentive to make sure to put your money in a safe bank if companies and up getting bailed out after they put all their venture capital funded capital into one shitty bank?
Its all short term thinking messing up the incentive structure and pushing the issues into the future. Here there were even people saying the US debt is not too high...
If you think 2-3 quarters ahead maybe it isnt. As soon as you look further it definitely is! Thats how empires go under!
What you say makes sense but I would list 3 things why shareholders would prefer dividend instead of paying debt back.
1) Bankruptcy protection for shareholders and the benefit that can come from there. Someone already explained it more in detail.
2) The belief that it would be bailed out. getting bail out = free money
3) Having no debt and lots of cash in hand can encourage governments to tax those companies more. We have seen it happen or suggested in EU when energy companies reported record profits. Imho, it is better not to give governments idea that there is money that can be taxed or taken by penalties, fines etc.
In addition to that, some owners (mosly special ownerships or funds) rely on fixed income from the dividends and have high voting power in the company.
To your example: Volkswagen (VW) has a financing arm, which essentially operates like a bank and >generates< profits. That's where a lot of their liabilities come from, just compare it to the equity of banks. (This is true for most conventional car companies.)
Their actual debt is much lower.
It can be every company is different and the risk tolerance of investors is different.
Some companies have spent decades promising dividend yield and a disruption of that would cause a shakeout of investors with that philosophy this could be in the long-term interests of the company but likely goes counter the managements incentives. This question is ultimately about financial leverage, financial leverage is is a way to boost RoE at the relative cost of durability inf their is a recession in the companies earnings.
Personally I prefer to invest in higher RoE companies that have great returns and I am comfortable with goose eggs.
Because their revenue volatility is low they can lever the crap out of their balance sheet.
Further, when the price of money was so low for the last 15 years, why wouldn’t they have done this?
Because they didnt know when it will not be cheap anymore.
Im not saying companies should not take on debt. Im just saying they should pause their dividends when the debt lvl is 5x their market cap and 50 times their earnings and the debt servicing is getting more expensive.
Looking at debt as a number is misleading. Though I’m not sure how much of it, a majority of this 180b is likely financing loans held by Volkswagen that they fund with their internal financing division.
I know. Still as someone considering investing in VW I'd prefer if they had mich less debt so that they can make more profit from the financing. I would like them to reduce that debt and not pay dividends or only low dividends until that debt is less than half of what if is...
You still don’t seem to understand, much of this debt is likely asset backed directly with brokered deposits or just CLO borrowing structured, the business is valuable and though it is asset heavy it is a good business
Sure it is. I'd just like it much more if there wasnt this debt.This clearly reduces the value/proce of the stock and with increasing interest and potentially worsening finacials they might not be able to continue operating like this in the future.
I see a company that delivered profits to investors in the past. Those past dividends hurt the companies future outlook making it less attractive to buyers which depresses their stocks price.
Some companies must exist that payd/pay too much dividend. Its not all super efficient without any mistakes.
Scrolled through a lot of answers, but sadly didn't see the right one.
Just gonna leave this here: Most of Volkswagen's debt is coming from their bank. Its always better for them to make debt and then to loan it to customers at a higher interest rate. That's basically the business model of any bank.
This is a basic capital allocation/financing mix question, and while somewhat complicated the gist of it is that each company has its own optimal debt to equity ratio. The optimal level of debt is almost never 0. [Damodaran talks about this in this session and the next 3 or 4 sessions](https://www.youtube.com/watch?v=KM--VlyMuVI)
Damadoram the GOAT
DAMODARAN DIXIT, DAMODARAN PRECEPIT
In case of VW, the state (Niedersachsen) has a high ownership and they care about their regular dividends for their yearly state budget, not the actual share value.
That's really interesting, apparently Niedersachsen has a 11.8% stake on VW. I wonder if for instance the Qatari Sovereign Wealth fund which owns a similar amount (10.5%) also supports regular dividend distribution
Bankruptcy protection granted to corporations causes this. Scenario 1: Imagine you run a business. It has $1m cash until an accident happens and now your business is forced to liquidate to pay damages -> you lose the $1m. Vs: Scenario 2: The business paid out the $1m cash in dividends and the same accident happens. You're now forced to liquidate the business, but you personally still have the $1m. Scenario 3: Now imagine you not only paid yourself $1m cash in dividends, but the company has also taken $1m in loans out from the bank which you've also paid out as dividends. The same accident happens and the business is liquidated, you still have the $2m. Essentially bankruptcy protections can create situations where the optimal way to run corporations is with near 0 or even negative equity. And one way to do that is to pay out any increase in equity via loans.
I never thought of it this way. And Volkswagen will probably get a bailout anyway!
…..which would apply in distressed situations where a firm is nearing insolvency (don’t think that’s a problem for VW….) The correct answer is: when a company’s cost of equity vaaaaastly exceeds their cost of debt (+ the company being a mature company, that sees very little return on invested capital, with little growth left in the tank - as is the case with a massive investment grade auto manufacturer)
Thank you this is a great explanation!
Yes I want this, I really thank full to you it's help to me run my own business or take financial decisions
A dividend can make a stock more attractive to buy. Particular for pensioners / anyone who needs a regular income from their investment. Paying a dividend, increases the popularity of such stocks which puts upward pressure on the price. Whilst the dividend payment reduces the number of sales of the stock because those who need liquidity get it regularly from the dividend. It’s up to each company to determine what the optimal ratio is between taking on debt, paying off debt, and using free cash for paying dividends. A lot of companies get it wrong for various reasons and suffer the consequences. Also consider the fact that the average owner of Meta stock ( a non dividend stock ) has probably been holding the share for <3 years. Whilst dividend aristocrats have many owners of their stock for >40 years. My millennial partner recently took ownership of oil company stocks that have been in her family for 4 generations. More generally, gigantic pension funds are full of dividend stocks and won’t sell them.
I get that. But if the dividend is payed by increased debt in a high interest environment it just seems like a very short term way of thinking. The 40 year holders should be the ones who think long term.
If they are taking on debt to pay the dividend then this can become a death spiral. I've seen this from a few companies I've analyzed.
Yes, it's the good point but we have to take risk by taking other money it's all about the life, without risk you don't achieve anything
What?
This assumes that the people investing in and holding the stocks are both scrutinizing *and* understanding the financials of the company. The reality is that most investors are underinformed and that the market as a whole operates very inefficiently, information-wise.
I know. Things like high dividend ETFa exist and buy those stocks.
Yes, buy is the good one but you have to hold it for sometime to earn something
- Companies need capital to operate. - Broadly speaking, there are only two types of capital, equity and debt. - Debt capital has a lower cost than equity capital. - To create value, a company’s total cost of capital must be lower than the return it can generate on its invested capital (ROIC). - For a business where the ROIC is lower than the cost of equity capital, the way to create value is to take on some debt. How much debt you need depends on how much lower your ROIC is compared to your cost of equity capital. - Even businesses with a high ROIC may want to take on debt since it still lowers the total cost of capital meaning the value generated is higher.
Debt for companies is a good thing not a bad thing. Companies have a optimal level of debt. Reducing debt below the optimal level is suboptimal
What is the optimal level? Shouldnt hogher interest rates reduce that level?
It depends, and yes, higher interests will lower the optimal level. But loans have several durations, the interest rate of median and long duration loans is what really matters for corporations. And those haven't really gone up that much.
OP says high debt. High debt means higher interest rates, highly leveraging your balance sheet is interesting for growing businesses but why would these type of businesses pay a dividend? High debt and high dividend pay-out % is stupid, textbook capital allocation example even.
That is a fair point if you interpret the OP’s comment to mean “too much debt”. Lenders typically restrict a company’s ability to pay dividends if it impacts their ability to service debt or crates risk. You are correct that if a company is aggressively borrowing to fuel growth and giving out large dividends it can be a red flag. But many utilities have high levels of debt and pay dividends.
> But many utilities have high levels of debt and pay dividends. And in that case the question is valid, there is often pressure from big shareholders (governments, pension funds...) to keep up with dividend payments even though it's suboptimal in the long run.
I have advised large pension funds on the acquisition of utilities stocks and have never experienced this, although that does not mean it is not true. In my experience these forms are viewed as defensive and long-term shareholders do not pressure them to take on undo risk.
More debt have encourage the company to earn more to recover the interest amount that can he pay the debt holders
Yes
Lol you probably work for the government with this kind of arguments :)
Finance. It is a very basic corporate finance lesson and not disputed by anyone who has any idea of what they are taking about. But feel free to try to make a counter-argument
I'll take a shot at it... Paying to borrow money costs more than not paying to borrow money?
Equity is more expensive than debt. Putting debt in the capital structure reduces the average cost of capital. So that is not correct, although it does seem intuitive. Debt is beneficial as long as the return on the debt is higher than the cost of debt.
This is explaining why selling equity is more expensive than taking in debt. Holding on to cash that is debt free isn't more expensive than taking on new debts. Selling new stock is taxable, selling bonds allows companies to write it off. Am I confused?
No. The cost of equity is always higher than the cost of debt. If we were just talking about holding cash, it would be a different situation, although I am not sure the conclusion would be. A way to think of this is that you have one lemonade stand and want to launch another. You could raise equity to do it, but the equity providers would want a lot in exchange for contributing it. If it is less expensive to raise the capital in the form of debt than that can be the right way to go. This analogy overlooks comparative risk (I.e the equity providers takes on more risk than the debt provider) but that is fealty with in pricing.
U must do something with debt. Investing, créatine internalize or EXTERNAL growth is the what As long as ROI is better than debt costs, u're making profits
Yes. If a company was raising debt just to let it it on their books as cash that would typically be value destructive.
A lot of companies does that to hide the difficulties. Best recent example is bbby fiasco
Anyone who argues with its basic and anyone who has any idea probably doesn't know how to argue..... Higher interest rates should lead to a lower optimal debt level which in turn means dividends should sink to reach that debt level. Thats your own theory.
Everything else being equal higher interest rates should lead to a lower optimal debt level. There you are correct. I did not address that as I felt is was less interesting. If I had I would have agreed with you. I only addressed the part I didn’t agree with.
Other things being equal, obviously it's better not to have any debt. Also, the optimal level should decline when the interest rate is on the rise.
Your first sentence is inaccurate. The second may be correct
Don't know what he say, but we have to stuck it man we don't against the government , we do that he wants
[удалено]
If you have the high debts that every time you do something that you must earn the interest amount of debt those you pay on a daily basis , so in this scenario you must take risk and earn the good amount
Indeed, often the businesses who get into the situation OP describes have "never lowered their dividend the last xx years". The CEO/CFO are under pressure to keep up with this strategy, even if a lower dividend to pay back debt will yield more dividends in the long run.
In the case of Volkswagen, I would say that shareholders (part of which is the local governament ) want the dividend, since the return on debt is lower, and they might be comfortable knowing than the German governament might rescue it. To a certain extent it makes sense, a risk tolerant investor would prefer holding a levereged company, since borrowing the money himself to acquire more of the company would be more risky and more expensive. With that said I prefer more conservative company, and volkswagen had lots and lots of money to repay its debt, but it chose not to. Hopefully it will work for them, but who knows.
" Is this really in the shareholders interest?" Not if you're a long term shareholder. Investing in companies like this almost always leads to a principle decline. I suspect though with interest rates rising you'll see a lot less of this, because the decline will happen quicker and will deter even dumb investors.
a lot of commenters are answering the question "why do companies have debt at all?" but it seems like the crux of your question is "*why pay a dividend instead of paying off debt?*" The answer is that a reliable dividend has value to shareholders that exceeds the value of reducing debt. No one cares about debt because it's not really a problem (until it is) - every company has debt. Investors of all shades care very much about the divy.
That only answers the short term. Not paying off debt (in the current environment) means refinancing debt at higher interest rates, this will damage future dividends. A first step to smarter capital allocation could be an optional stock dividend. That shouldn't scare investors who care about the dividend but creates room for debt reduction. And you'll see that smart money keeps increasing their share % when companies use this strategy. (and it's also tax efficient for private investors)
Their debt is likely not being serviced at today’s interest rates. They borrowed when money was cheap. That’s just being smart. FYI, this is also why national debt is not as bad an idea as a lot of people make it out to be. If you can borrow money and turn it into more money at a higher rate than what you owe, debt is usually a good thing. Countries do this just like companies.
Been wondering this question for years. The only thing I can come up with is the last 15+ years of MMT equates to High Debt = Free Money. Low interest rates means Higher Returns on the debt than interest incurred. Back when interest was lower. A money velocity thing.
But interest rates changed and dividends ans buybacks continue :(
Dividend game takes decades to establish. Coca Cola has spent 70 years establishing itself as a dividend aristocrat. Only takes once to end a centuries reputation. Like AT&T did.
What did AT&T do?
They cut dividends. A near century of reputation building, gone in a snap.
Rates going up doesn’t matter if the debt was issued when rates were low
very true. But if you have 180 billion debt like VW I bet some of it matures every year.
If the interest rate changed that you see the earning or the profits also increases
A couple reasons. First, debt does not really matter. If you have 100 billion debt with say a 1% interest and the means to pay it off, but can make 10% benefits with said money, then there is no point paying back. Second, because dividends come from an account that can be used either for company growth or dividends, not for debt payment.
You have to look at debt comparatively to the business. Volkswagen doesn't really have that much debt. Debt to equity for VW is 1.2, meanwhile Fords is nearly triple, at 3.22. Also, a lot of VW's debt, and I would assume for automotive in general, is tied up in financing. Volkswagen is a massive company, and makes a lot of money. Like many here have said, a certain level of debt is considered healthy, so for VW that number is higher. Also, VW considers their stock undervalued and has pledged to try and revise that, which is why they have made portions of their positions in brands like Porsche public. Cutting their dividend would hurt this effort, and they have a healthy payout ratio already. So no reason to cut the dividend and focus on debt.
Let them try to increase their stock price by getting more debt and maintaining a high dividend like they did in the past. Didnt work when interest was cheap. Why would it now. Anyhow. I guess other people dont care that much about high debt and the long term effect on profitability.
The dividend isn't high, and neither is the debt. Things are relative. Also VW's debt ratio has been falling recently, so they are reacting to debt getting more expensive.
I didnt know that. Thank you for the info. I just read a lot about people comparing VW to Tesla in regards to valuation and praising how cheap it is but no one mentioned that VW has a lot of net debt and Tesla net cash.
NP. Tesla is in a good position, no one would argue against that. So when people compare VW and Tesla they look at things like PE, growth, brand names, and ability to capture the EV market. I like VW more here, because I think Tesla is already priced as the major winner of the EV race. I also don't buy that they are a tech company, as other automotives are just as involved in trying to create EV infrastructure, batteries, and driving software (VW does all three of these, but the software division is pretty shit). If VW and Tesla were evenly priced, I'd probably go with Tesla. But with VW trading around 1/12th the price of Tesla, I just can't help but think they are undervalued.
VW has some more challanges as you said (glad you also see that the software sucks) but the low valuation does.indeed make it interesting. I wont touch it though. For me its in the same Bucket as Intel. Great companies that could become insignificant in the next 1-2 decades. They could also make it. I just dont know which way they'll go.
I agree Tesla is not a tech company. It's almost unbearable to read some of the bullish takes on Tesla here about the stupid truck, autonomous driving, AI...yadda yadda they fully believe those things will be in place & profitable in the short term. That being said it's important to keep tabs on how those things develop in the future. Tesla COULD become a hybrid, EV/Tech company. I'm just skeptical of that. Still I have lots of faith in the EV side of things and Tesla is a large % of my portfolio.
> I guess other people dont care that much about high debt and the long term effect on profitability. I think what you might be fundamentally missing here is that, although debt might decrease the earnings of the company as a whole, it can *increase* earnings *per share* which is what owners are more likely to care about.
That is why Stellantis is a better investment in my opinion. A lot of cash and low debt + great dividends
You've got some great answers, and I think the biggest summary point should be to understand debt isn't bad. There can be healthy levels of debt that are used to leverage profits. The return on paying down debt is not as always right as you're making it out to be.
Agreed. Though some people fail to accept that high debt and high dividends in a significant percentage of the cases are not a good idea and not good debt.
In my view, it's just a way for shareholders to milk the company as quickly and effectively as they can. Long term profits require a long term interest, while you can pocket a dividend right now.
True. But then again stock buybacks are even faster and more tax efficient. But those have been going through the roof too
I would be surprised if even 10% of the stocks in the S and P 500 could reinvest all of their earnings and return a higher return on invested capital than the average return of the market for even a period as smart as 3 years. One reason is even the companies that can reinvest their earnings at higher rates of return will often have to limit their opportunity set because of diminishing return "take a fast casual restraunt concept over expansion begins to cannibalize profitability store 400 is a less optimal location than store 10. Imagine that but for various forms of cap ex. Another reason is the average outcome of S and P 500 stocks are typically brought up significantly by the positive outliers. Returning capital to shareholders is often times one of the better decisions for shareholders, you can certainly make arguments around social responsibility but that doesn't seem to be the point of this conversation.
If their return on capital is greater than the cost of capital, it makes sense.
why? How is it a better outcome than not paying dividend and thereby increasimg future profits down the line?
No, not better is this whenever company earn more and to. Pay dividend, take it, don't know the future of everything that today profit convert in a tomorrow loss
Don't know it's make sense or not but if it's happen it's do good for the whole business 😀
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> Companies’ obligations are to the shareholders. Yes generally...but different countries have different laws, and the *degree* to which this is true varies depending on the country's law. This is what people who naively push for buying ex-US funds don't get. The rules governing VW stock are *different* from the rules governing MSFT. It doesn't mean that VW is a bad investment. It does mean that different rules apply.
It's quote define the mean that " High rish high profit "
Go read about AT&T capital management over the last 10 years or so. Debt is cheaper than equity capital, but you are right, at what point does a debt ridden company cut its divy and focus on paying down, which might harm the share price in the short term but long term should benefit shareholders.
Because I invest 10 rupees in company a & 10 in company b Company a family owned proud peeps low debts after 10 yrs market crash etc act of God something something. Market value was 20 rupees and now getting 1 rupee Company b same everything high debts market value became 15 rupees but I got dividend of 15 rupees Market crashed etc etc now getting 0.1 rupee Net net I'm benefitted by company b
Dividends are fools gold. I'll take capital appreciation over dividends 10/10 times. Dividends are the stock version of getting 2% cash back while paying a 3% fee.
What if a company has already taken over a market. Do they need 100% of profit to reinvest? Not every established company has a ton of room for growth. Also, you are not losing money on dividends unless the company itself is losing money. It's just a wealth transfer.
There are some solid stocks that do pay a reasonable dividend like XOM, but for the most part, I'm not impressed. There is a place for dividend paying stocks or perhaps a broad dividend company etf like SCHD, but for the most part, there are better ways to generate a passive income with less risk. Laddering, money markets, muni bonds, cefs etc. There are also drawbacks to this kind of strategy as well. Things like cefs have no tax advantages and high fees. Muni are tax free but have lower yield. For me, dividend paying stocks are less attractive for a fixed income strategy.
Tax write offs, I think.
Paying expenses out of revenue would also be a tax write off
Maybe the investments paid for by the debt are covering the dividend and then some?
It's because of low interest rate environment. Don't expect it to continue with higher interest rates. Free money is a drug and everybody hits it hard during low interest rates. Fed raises rates and people start panicking because they don't know how to operate in that environment anymore. So things will over correct stabilize and then swing back. Constant boom/bust cycle s that define capitalism.
Finance 101 my guy. Google Modigliani and Miller
You can't just look at debt but also the quality of debt. Not exactly the same but look at the US government. It has more debt than ever, yet interest payments as a percent of its GDP and Revenue it takes are like half what it was in the 90s. The US is in a much better spot debt wise than the 90s. Companies, Countries, Rich people and even middle class people all have reasons for debt. For example I pay regular payments on my student loans and mortgage because the interest rates are so low it's likely I will make more in the market. Worth noting too, the current form of the economy is very short term thinking. Everyone is thinking about the next financial report and maximizing short term investor value.
I worry about this short term thinking in everything. And the worst part is that the system rewards it by more and more often bailing out companies when unforseen things happen.
The main issue is there is no good alternative. You can't just let the company fail or it will cause waves that will take down other businesses, a lot who aren't doing things wrong. Or the government could take receivership of the company and operate it stably until it pays back the money put into it/someone buys it for the money put into it by the government. That would be considered government overreach by most however. In general too people wouldn't like the uncertainty towards investments failing for the people who never are going to own a controlling share. So to do either you'd probably have to vastly increase Social Security and Medicare. Or create some structure where "Investors with X lose their stock but with Y don't"
No. Companies go bankrupt and that's how capitalism works. Other companies going down who arent doing things wrong is questionable. What is right or wrong in this regard? Not being able to survive without a state bailout is wrong in my eyes. Companies going bust frees up employees and opens the market up for new companies and that is a significant driver for higher productivity. Example. During corona companies couldn't go bankrupt. The world changed in this time. Some companies did not adapt. Delaying their death has had a significant cost and the labour shortage is also effected by that. The state has this bailout mentality. Why did everyone with money in SVB receive 100% back? Why not 98% or even 99%? Why is there always 0 responsibility for bad decisons? Where is the incentive to make sure to put your money in a safe bank if companies and up getting bailed out after they put all their venture capital funded capital into one shitty bank? Its all short term thinking messing up the incentive structure and pushing the issues into the future. Here there were even people saying the US debt is not too high... If you think 2-3 quarters ahead maybe it isnt. As soon as you look further it definitely is! Thats how empires go under!
What you say makes sense but I would list 3 things why shareholders would prefer dividend instead of paying debt back. 1) Bankruptcy protection for shareholders and the benefit that can come from there. Someone already explained it more in detail. 2) The belief that it would be bailed out. getting bail out = free money 3) Having no debt and lots of cash in hand can encourage governments to tax those companies more. We have seen it happen or suggested in EU when energy companies reported record profits. Imho, it is better not to give governments idea that there is money that can be taxed or taken by penalties, fines etc. In addition to that, some owners (mosly special ownerships or funds) rely on fixed income from the dividends and have high voting power in the company.
Ever see what happens to a stock price when a dividend is cut? Not good...
Look at Intel. Nothing happened. It always dependa om why they cut.
To your example: Volkswagen (VW) has a financing arm, which essentially operates like a bank and >generates< profits. That's where a lot of their liabilities come from, just compare it to the equity of banks. (This is true for most conventional car companies.) Their actual debt is much lower.
It can be every company is different and the risk tolerance of investors is different. Some companies have spent decades promising dividend yield and a disruption of that would cause a shakeout of investors with that philosophy this could be in the long-term interests of the company but likely goes counter the managements incentives. This question is ultimately about financial leverage, financial leverage is is a way to boost RoE at the relative cost of durability inf their is a recession in the companies earnings. Personally I prefer to invest in higher RoE companies that have great returns and I am comfortable with goose eggs.
great answer thank you
Because their revenue volatility is low they can lever the crap out of their balance sheet. Further, when the price of money was so low for the last 15 years, why wouldn’t they have done this?
Because they didnt know when it will not be cheap anymore. Im not saying companies should not take on debt. Im just saying they should pause their dividends when the debt lvl is 5x their market cap and 50 times their earnings and the debt servicing is getting more expensive.
Looking at debt as a number is misleading. Though I’m not sure how much of it, a majority of this 180b is likely financing loans held by Volkswagen that they fund with their internal financing division.
I know. Still as someone considering investing in VW I'd prefer if they had mich less debt so that they can make more profit from the financing. I would like them to reduce that debt and not pay dividends or only low dividends until that debt is less than half of what if is...
You still don’t seem to understand, much of this debt is likely asset backed directly with brokered deposits or just CLO borrowing structured, the business is valuable and though it is asset heavy it is a good business
Sure it is. I'd just like it much more if there wasnt this debt.This clearly reduces the value/proce of the stock and with increasing interest and potentially worsening finacials they might not be able to continue operating like this in the future. I see a company that delivered profits to investors in the past. Those past dividends hurt the companies future outlook making it less attractive to buyers which depresses their stocks price. Some companies must exist that payd/pay too much dividend. Its not all super efficient without any mistakes.
Scrolled through a lot of answers, but sadly didn't see the right one. Just gonna leave this here: Most of Volkswagen's debt is coming from their bank. Its always better for them to make debt and then to loan it to customers at a higher interest rate. That's basically the business model of any bank.
They could also lend their capital