Investing: the importance of dividends

Today I'm going to get into a subject that so many have written so much about, and that I have relatively little experience with: investing.

Some time ago, I was listening to an episode of The Ongoing History of New Music about collectibles. The host, Alan talked about various rare, limited-edition CDs and LPs, played some music from them, and said how much they're worth now. One or two of them are worth a lot of money. Most of them are worth somewhere between 5 and 20 bucks. (It's been a while since I listened to it, so I might be a bit off on the price range.) That's not a bad price for a used CD, if you're on the selling end, but still, it's not a lot of money. The host made an important point: if you're going to buy a collectible, buy it because you want it; don't buy it as a financial investment.

That got me thinking, his advice could apply to any investment. Lots of investments go up in value a lot more reliably than collectible CDs and LPs, but something has to drive that increase. Some investments, like houses, provide something of physical value (such as shelter) while you own it. Others (like a savings account or GIC, or a house that you're renting out) pay money while you have money invested.

Which brings me to another very popular form of investment: the stock market. Some stocks pay dividends, so they're not just something you buy now to sell for more money later. Other stocks don't pay dividends. These companies want to put all of their profits into growth, for now. Some companies, like Google, have no plans to pay dividends in the foreseeable future. I wonder when (or if) they'll pay dividends. I'd like it if they'd give some indication of when they want to start paying dividends. Even though it seems like the most stock market money can be made by buying low and selling high, not by waiting for a slow trickle of dividends, I think every company should eventually pay dividends.

It would make sense to me that every company should plan to pay dividends eventually, but apparently some people are "critics of dividends," so I'll say a bit more to defend my view.

Ultimately, I believe that the hope of future dividends should be the only thing driving stock prices. A typical dividend-paying company pays the same amount per share every quarter, occasionally changing the amount. It seems hard to believe that this could drive the fluctuations in a company's value that can happen in minutes, but I suppose things that happen during the day can affect the company's prospects years down the road. If a company's price isn't affected by the hope of future dividends, then it's only driven by the hope that someone else will pay more later. And they will only be willing to pay more because they believe someone will pay even more later. This infinite chain seems like a flimsy foundation for a company's value. Sure, shareholders own an asset while they own the shares, but it's an asset they can't use. What good is that?

Let's imagine a stock market where no companies pay dividends. Then any money you make from the stock market has to come from outside of the stock market--employment income, small business income, interest from other types of investments, and debt. The amount of money coming out of the stock market as people sell has to be less than or equal to the amount coming in from buyers. This sounds kind of like a casino. The house (in this case, the stock brokers) always wins. Some others win and some others lose, but on average, they lose.

But in real life the stock market goes up on average. People do make money from it, and not just from dividend-paying stocks. Maybe that's because more and more people are investing more of their money. If the number of investors and their wealth stops growing, the value of stocks would stop growing (again, assuming no dividends). If you can't make money off your investment without a growing number of people coming in after you, investing even more money, you're in a Ponzi scheme.

I can only see two differences between investing in a Ponzi scheme and investing in a company that will never pay dividends:

1. Ponzi schemes makes more consistent profits (for a while).

2. In a Ponzi scheme, you don't really own anything. In the stock market, you own something you can never use; you can only sell it to someone who also can never use it. Is this really a difference?

Am I missing something here? Or do all successful companies eventually pay dividends, or sell out to a company that pays dividends?