Yesterday, Berkshire Hathaway’s (BRK.B) 2013 letter to shareholders was posted on the company’s website. As a long-term follower of Warren Buffett, I voraciously read through every single word of it. I was particularly excited that Buffett spoke about dividends and dividend paying stocks on several occasions in the letter. His standing on paying dividends have always perplexed investors in Berkshire. In fact, I have even referred to him as a closet dividend investor before. In this article, I am going to post my thoughts on the letter.
At the very bottom of the letter, Warren Buffett discusses why it makes sense for Berkshire Hathaway to continue not paying dividends. In essence, he comes to the conclusion that reinvesting all profits at above average returns will serve shareholders better in the long run, than paying dividends. This reinvestment of capital refers to either direct reinvestment back into the business that generated them or by purchasing new businesses that generate high returns on equity. This sounds like a reasonable idea, and is one that Buffett has been very successful at since the mid 1960’s. One of Buffett’s arguments against paying distributions was that investors, who require income, can easily afford to sell a portion of their shares every year. In his theoretical example, all earnings were reinvested at a constant rate of return, and the stock price always traded at a premium to book value. The main issue I had with his thinking was that in the real world, things are not linear at all. Stock prices fluctuate wildly above and below book values, and reinvested rates of returns are often equally volatile.
Overall, Warren Buffett is not interested in distributing profits to shareholders in the form of dividends, because he believes that he would be much better at allocating cash than ordinary shareholders. While plowing all of realized earnings back into the business or in new ventures comes with its own sets of risks and limitations, Buffett has proven his uncanny ability to reinvest successfully. He is after all, the Oracle of Omaha, and the most successful US investor. Unfortunately, he is in his 80s, and is close to retirement. As a result, given the massive scale of Berkshire today, the success of future acquisitions might not lead to similar extraordinary performance. In addition, although keeping all earnings into Berkshire might have worked for Buffett and his followers, there are only a handful of companies which have managed to do the same, and be successful at it. In your typical US Corporation, the overpaid management is greedy for acquisitions and empire building at all costs, since they have very little if any actual stake in the business. Expanding your business is often subject to limitations, as I explained in an earlier article.
In essence, Buffett’s Berkshire is acquiring businesses, shares in businesses with its excess cashflows that didn't need to be invested in its existing subsidiaries. In a previous article I have argued that dividend investors can similarly create their own mini-Berkshire style portfolios, by investing in dividend paying stocks, and reinvesting distributions into attractively-priced shares. Incidentally, the largest four portfolio investments include Wells Fargo (WFC), IBM (IBM), Coca-Cola (KO) and American Express (AXP), all of which pay dividends. In the case of Coca- Cola and IBM, we have companies that have raised them for years if not decades. These businesses and shares generate additional cashflows that need to be reinvested. In his letter he said the following:
“Most companies pay consistent dividends, generally trying to increase them annually and cutting them very reluctantly. Our “Big Four” portfolio companies follow this sensible and understandable approach and, in certain cases, also repurchase shares quite aggressively.
We applaud their actions and hope they continue on their present paths. We like increased dividends, and we love repurchases at appropriate prices.”
Buffett focuses on businesses with the potential to generate growing cashflows over time with limited needs for investment, and then utilizes his experience as a capital allocator to reinvest profits into more income generating assets.
Full Disclosure: Long KO
- The Most Successful Dividend Investors of all time
- Warren Buffett’s Dividend Stock Strategy
- Why dividend investors should never touch principal?
- Build your own Berkshire with dividend paying stocks
- This week's highlight: making it into the Carnival of Personal Finance
The goal of every dividend investor is to generate dividend income that is larger than their annual expenses. This coveted goal is called th...
Dividend growth stocks are the gift that keeps on giving . I like the fact that most of the work in selecting good dividend growth stocks is...
I have been a dividend growth investor for over 7-8 years now. The reason why I have somewhere between 85% - 90% of my networth in dividend ...
I love it when the stock market goes on sale, like it has been so far in the past two - three weeks. For aspiring dividend growth investors,...
How do you define success? To me, success is the freedom to do my own thing, and the ability to reach my goals. Given the fact that I am a f...
One of the biggest sins in investing, is investing money without a clear plan or strategy to accomplish specific goals . This investing sin...
I have received quite a few emails recently, asking me how I manage my dividend portfolio . In general, I focus on several things that I b...
There are many risks to investing . One of the major risks that could ruin a portfolio’s chances of generating adequate dividends are p...
Before I begin my message, I wanted to wish all my readers a Happy 4th of July. And I wanted to thank all of those military members for keep...
I am a fan of diversification as a tool to reduce risk. I diversify by buying at least 30 – 40 securities, representative of as many sectors...