Should Berkshire Hathaway pay a dividend?
Just asking the question is enough to make some shareholders cringe. After all, Warren Buffett has one of the best long term records when it comes to intelligent deployment of capital. However, asking this question is perfectly appropriate. The value of any business is the present value of all of the cash flows produced by the investment from now until the end of your holding period. For common stocks, cash flows are realized either through dividends or through the sale or liquidation of the holding. For a business like Berkshire that does not pay a dividend, an investor’s return is based entirely on the eventual price one obtains when the shares are sold.
By now you may be thinking that I’m looking at this from a short term perspective, but the points above are true regardless of whether your holding period is a year or fifty years. Buffett himself has made this point on numerous occasions.
Over the past 44 years, Warren Buffett has done a masterful job of deploying capital within Berkshire. Without this reallocation of capital, Berkshire would have ceased to exist long ago as a failed New England textile manufacturer. Instead, Buffett systematically redeployed cash flows from the textile business into opportunities with greater returns on equity. Buffett first entered the insurance business in the late 1960s and harnessed the power of “float” which produced additional funds for investment. Over the last several decades, Berkshire has been built into a conglomerate that produces prodigious amounts of cash flow each year. This cash is then reallocated within Berkshire or used for acquisitions. Just because cash is produced within one operating unit does not mean that it is reinvested in that operating unit. Each unit has to justify investments and compete against other opportunities for Berkshire.
When I consider whether a company should pay a dividend, I always ask a very important question:
Does each dollar of retained earnings result in at least a dollar of added intrinsic value?
Clearly if the company is destroying intrinsic value by retaining earnings and deploying into sub par opportunities, the funds should be distributed to shareholders. In many companies, the “institutional imperative” dictates that funds are retained to build empires and consolidate power. Sometimes the funds are wasted on above market executive compensation or other boondoggles. The boards of such companies should insist on shareholder distributions if the return on equity of retained earnings is sub par.
How has Berkshire measured up?
I would say that the record more than speaks for itself. Berkshire is a compounding machine and has been for several decades. Over the past decade, Buffett has been criticized on several occasions for sitting on piles of cash at very low yields. While this is accurate, I look at this as a small price to pay to give an investor with Buffett’s track record plenty of “ammunition” for opportunities when they eventually arise. Over the past year, we can see that Buffett has had many opportunities to deploy this cash at very attractive returns. Some might ask why individual shareholders could not do the same if they received the cash for reinvestment. Well, for one thing, you have to pay at least a 15% tax on the dividend so immediately you are only working with 85% of the capital that would be available to Buffett. Furthermore, are you in a position to call Jeff Immelt or Lloyd Blankfein and arrange the type of investments that Buffett secured at General Electric and Goldman Sachs? I know that I am not in that position.
The reality is that someday, Berkshire will pay a dividend. However, in my view, that day has not come yet. The current economic climate and the more reasonable valuations available in both public and private companies makes it an ideal time for Buffett to have as much cash on hand as possible. Buffett’s reputation alone is a huge asset particularly when it comes to the purchase of private family held companies that care about the long term stability of businesses built over a lifetime. Many times, there is only one person to call to achieve liquidity while also ensuring stability for your company.
When the phone rings in Omaha, I want Buffett to have as large of a checkbook as possible under current conditions.