How Do You Value a Public Company That Does Not Pay Dividends?

Dividend Not a Decisive Factor

Dividend can be a factor in valuing a stock, but more often than not it serves as a stabilizing factor for the stock price. For example, XYZ stock that is trading at $20 pays a dividend of $1, a 5 percent yield. If the stock declines to $15, the yield increases to 6.6 percent, making the stock more attractive to investors, who will start buying it for the high dividend yield, and their buying will push the stock price back to $20. As a result, stocks that pay dividends fluctuate less than stocks that don't, but dividend yields can vary from 1 to 10 percent, so the dividend by itself is not a critical factor in determining a stock's value.

Stock valuation models can be very sophisticated; many are proprietary. Some analysts may look at the total size of a potential market, estimate a company's share of it and work back from those numbers to value a stock. Many use a company's present and future earning power as the basis for valuation. Company assets by themselves mean little to investors because in liquidation they are likely to fetch just pennies on the dollar. What is valuable is the ability of a company to make money with those assets. Assets can be physical, such as plants or equipment to make a product, or intangible, such as patents for a new technology.

The most typical problems with valuation models are multiples, assumptions and hidden motives. Even if an analyst accurately estimates the total size of a market and a company's share of it, the question still is: What valuation multiple, such as sales per share or price-to-earnings ratio, should be used? Different analysts may use different multiples, or the same analyst may change his multiples as market conditions change. An analyst's assumptions may be wrong, or he may simply tweak his assumptions to reach the desired result for a positive stock recommendation rather than determine the stock's true value.

In the end, a stock is worth what investors are willing to pay for it, so the best (and often the fairest) value is the price that the market puts on a stock. A stock price reflects all known information about a company at the time and is adjusted as new information comes in. A stock price is also influenced by supply and demand. If there is too much stock for sale, it may never reach the price target put on it by an analyst, no matter how accurate his valuation may be.