Source: Flickr user frankieleon.
Dividends are often the foundation upon which the best retirement portfolios are built. Even though a dividend of 2% or 3% annually might not seem like much, the ability to reinvest that dividend back into the same stock can compound your gains even faster.
Dividends do so much more than just put money in your pocket. They are often a beacon for investors to follow that imply a company is profitable, and that its business model is geared to stand the test of time. A dividend payment to shareholders also signifies that the management team of a particular company strongly believes in sharing profits with its shareholders. A strong sense of fiduciary responsibility is a great thing for a management team to possess.
Why companies choose to not pay a dividend Yet, not all companies pay dividends. For some, it simply comes down to profitability. If a company isn't turning a profit, or is heavily indebted, paying a dividend to investors wouldn't be a prudent move, as it might be unsustainable. By a similar token, some businesses just require a lot of capital investment, making a regular dividend payment something of an iffy proposition.
Among megacap stocks -- which I'm arbitrarily assigning a valuation of $75 billion or higher -- there are less than a dozen companies that aren't paying a dividend. Googleis one, though it's widely expected to begin paying a dividend sometime soon with nearly $55 billion in net cash in its coffers.
Three megacap companies that shouldn't pay a dividend However, there are a handful of additional megacap stocks not currently paying a dividend -- and I believe they should stay the course. Here are three that come to mind.
1. Facebook When it comes to social networking sites, there isn't a company on Earth consumers show more brand loyalty toward than Facebook.
According to Facebook's 2014 year-end earnings release, it wound up with 1.39 billion monthly active users (a 13% increase from 2013) and 745 million mobile daily active users (a 34% increase from the prior year), and it generated free cash flow of $3.63 billion on net income of roughly $5 billion. By all standards, it was another banner year for Facebook.
As the premier social networking destination for a majority of Americans, Facebook is able to use its clout, along with consumer interaction, to command premium pricing from advertisers who are looking to target their ad directly toward people who'd be most likely to act on it. What Facebook won't be doing anytime soon, though, is paying its shareholders a dividend.
Why? Because the Internet is extremely fluid and requires constant innovation. Facebook is going to need to continue to spend freely if it hopes to maintain its market share dominance among social platforms.
Per its fourth-quarter report, Facebook's GAAP costs jumped 87% to $2.72 billion during the quarter. Hiring new employees, beefing up its research and development, and boosting its own marketing presence are all reasons Facebook's cash generated is being funneled back into the business rather than to its shareholders. In Q4 alone, R&D costs nearly tripled to $1.11 billion from $408 million in the prior-year period.
I suspect that until Facebook's growth rate slows into the mid-single-digits, the calls for a dividend will probably go unheeded.
2. Celgene If there's an industry that requires an inordinate amount of capital reinvestment to be successful, it's the biotech industry.
Few biotech stocks pay a dividend, which isn't surprising since most are losing money. But, the same holds true for those making money, with a few notable exceptions, such as Amgenand, more recently,Gilead Sciences.
With more large-cap biotech stocks suddenly paying out a dividend, some on Wall Street have wondered whether Celgene might be next. My personal suggestion is that Celgene continue to avoid paying a dividend for years to come.
For starters, the biotech industry is highly capital-intensive, and it requires that a good chunk of free cash flow be reinvested back into research and development. A number of biotech stocks in recent years have used their free cash flow for acquisitions, but that's not Celgene's typical method of growth. Instead, Celgene prefers to grow its product portfolio and pipeline organically, leading to substantial research and development as well as clinical study expenses. In fact, the unique aspect about Celgene that could allow it to one-up its peers is its ability to expand its label indications for its three big drugs: cancer drugs Revlimid and Abraxane, and anti-inflammatory Otezla.
The other component to Celgene's success is its ability to form collaborations to spur growth. Celgene's management team is realistic in the idea that the more it partners up with smaller biotech stocks, the better chance it has of landing multiple blockbuster drugs. These collaborations often require an up-front payment to its partners as well as potentially hefty development, regulatory, and sales milestone payments. Celgene needs to ensure it has enough cash on hand to cover these payments, which all but ensures, in my opinion, that it will have no desire or need to pay a dividend anytime soon.
3. Amazon.com Lastly, online retail giant Amazon.com should continue to stick to its ongoing strategy of maximizing revenue and funneling nearly all free cash flow back into its business rather than paying a dividend.
Similar to Facebook, online marketplaces are constantly changing, and businesses need to be able to respond quickly to industry changes. Amazon has been focusing in recent years on expanding its business into international markets like China, as well as working to improve satisfaction among customers with the site. Perhaps nothing has been more instrumental to Amazon.com's success than Prime.
Source: Amazon.com, Facebook.
Begun a decade ago, Prime has transformed how consumers use Amazon, allowing them "free two-day shipping" on all goods as long as they've paid an annual membership fee. In 2011, Amazon added the perk of being able to stream content on an unlimited basis for Prime members. In spite of raising the annual Prime fee by 25% to $99 in 2014, in the fourth quarter, Amazon reported that Prime subscriptions jumped by 50% in the U.S., and even more in international markets. Per CEO Jeff Bezos, Amazon invested $1.3 billion in Prime Instant Video in 2014 alone!
But, Amazon isn't just making defensive investments. A lot of its rising costs have come in the form of new technology or content research. On top of a growing digital library for Prime customers, Amazon is experimenting with the idea of drone delivery. It could be a ridiculous idea, or it may wind up being absolutely game-changing.
The point is, Amazon.com's investments continue to be aggressive and geared at keeping its revenue growth and market share head and shoulders above its competition. Until such point as Amazon's growth rate begins slowing considerably, there's no reason for Amazon to even consider paying shareholders a dividend.
The article 3 Mega-Cap Stocks That Shouldn't Pay a Dividend originally appeared on Fool.com.
Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool recommends Amazon.com, Berkshire Hathaway, Celgene, Facebook, Gilead Sciences, Google (A shares), and Google (C shares). The Motley Fool owns shares of Amazon.com, Berkshire Hathaway, Facebook, Gilead Sciences, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.