Value Investors Tribe

Berkshire Hathaway is one of the largest companies globally based on market capitalization and ran by Warren Buffett. Berkshire Hathaway has been growing its revenues, earnings and cashflow considerably over the past decades and yet, it has never paid a dividend. Warren Buffett has been asked multiple times in Berkshire Hathaway’s annual shareholders meeting, interviews and other archived communication about his rationale of not paying out a dividend.

In May 2012, similar question was asked to Warren Buffett in an interview by Fox Business, “When the largest percentage of S&P 500 companies are now paying out dividends and the fact that you own dividend paying stocks like Coca-Cola, American Express, Intel, why won’t you pay a dividend to your shareholders?” Warren Buffett explained, “We think that our shareholders, five years from now, will be wealthier, counting what they would get from the reinvestment of the dividend.” Warren continues by saying that they retain the money and reinvest so as to create shareholder market value of greater than $1 for every dollar retained. Warren states that they may be wrong but historically this criteria has been met.

What Warren basically looks for is, for every dollar paid out as dividend, would the company generate value higher than a dollar or not, if he is confident that this shareholders value created by retaining a dollar is higher than paying it out, Berkshire Hathaway retains that dollar and does not pay dividend. This is an interesting concept to look for management’s effectiveness when analyzing other companies who pay out dividend regularly. As Charlie Munger famously said that past performance is a good measure to understand what to expect in the future.

Historically, retaining dividends has produced multifold returns for Berkshire Hathaway shareholders and Warren Buffett has been able to create higher shareholder value. Additionally, it is important to consider tax levied on dividends payout. Consideration of taxes can change evaluation of paying out a dividend is rational or not considerably since dividends paid out are taxable however retaining same amount for reinvestment in business is not taxable.

It is interesting to note that recently, over the last five years, Berkshire Hathaway has failed to meet this test purely because of the mammoth company it has become. Hence, it will be interesting to see how Oracle of Omaha maneuvers this challenge, maybe a dividend declaration is on its way!  

Key Takeaways:

1. Management should evaluate if shareholders are better off paying the dividend or retaining the amount and reinvesting it. Management’s effectiveness can be evaluated using this test.
2. Berkshire Hathaway has been able to create shareholder value higher than the potential dividend payout over the five years rolling period.
3. Dividends are taxable however retaining same amount in the business for reinvestment is not taxable.