BRK should pay a dividend and start an investment advisor subsidiary

[Guest Schwab711]

I understand that the build-up of a diversified and controlled non-insurance earnings stream creates a competitive advantage for the reinsurance arm (and GEICO/industrial subs, to a lesser degree), but I think BRK shareholders would currently be better served if BRK paid a small, once-a-year, and variable dividend (could target a roughly bi-annual special dividend instead of something predictably frequent). I'm not a big fan of the PCP acquisition and I think a return of capital or nothing would have been better. It would also lower the minimum size necessary to "move the needle". Even with the $9b bond sale, shareholders will earn roughly 10-11% pre-tax ROIC on the PCP purchase, assuming margins don't fall again in 2016.

 

I don't think a spin-off of any major unit makes sense anymore. However, I think a Yahoo-like strategy where they create a "Berkshire Investment Advisor" sub would be an excellent, capital-light, move to take advantage of "Berkshire" name while providing BRK an option to spin-off their large, non-controlling equity stakes on a tax-free basis, if they ever wanted to. WEB loves financial flexibility and stable, high-ROIC cash flows (but who doesn't). If it could be used to monetize their deferred tax assets then it would seem worthwhile. Depending on the structure, it seems like they could reduce their expected tax burden on future financing transactions (think BAC, DOW, and GS warrants)

 

I'm guessing this isn't as simple as I think. If they ever did spin-off the IA they would surely want to drop the Berkshire name, which probably dings the value and potentially hurts their reputation. I assumed NE or CA would be the natural regions to launch in. WFC has >10% deposit share in NE (AUM share appears to be higher) and BAC/WFC's ~43% deposit share in CA (wow!). I guess he could start on the east coast? On second thought, this proposal may be as ridiculous as suggesting BRK buyout MCO or something.

 

Either way, I prefer the Berkshire IA in the US or a regular special dividend vs. Berkshire re-insurance in Australia and heavy invests in AU banks while their housing market looks like 2005 Florida.

 

Anyone have any thoughts on why this is genius or poorly thought out?

 

http://www.nebankers.org/images/files/pdf-public/communications/press-room/bank-statistics/marketshare-rpt-by-marketshare.pdf

https://www.snl.com/irweblinkx/depositmarketshare.aspx?iid=4074352

[JBird]

I think BRK shareholders would currently be better served if BRK paid a small, once-a-year, and variable dividend

 

Why?

 

So you receive $1 in dividends, and you net 85 cents. Have you thought about what rate you would have to compound at to make this sensible?

 

If Berkshire compounds at 10% for a decade, you need to compound your dividend proceeds at 11.8% just to match Berkshire's performance.

 

If you're in the top marginal tax bracket paying a 20% tax on dividends so you'd have to compound at 12.5% to break even.

 

Are you hoping for a dividend because you have so many other better investment opportunities?

[Guest Schwab711]

If Berkshire compounds at 6% then you have:

• 7.1%
  
• 7.5%

 

I think it's possible and maybe likely that the majority of his shareholders could find at least one deal (maybe 1%-2% of their capital, assuming 100% allocation) with higher returns. I wouldn't have wrote this if I thought the floor for BRK was 10%.

[thepupil]

there are some bizarre things in this post.

 

If it could be used to monetize their deferred tax assets then it would seem worthwhile.

 

Berkshire has a $63B deferred tax liability, not an asset. The goal is to not realize this. The best way to  "monetize" it is to do nothing.

 

I assumed NE or CA would be the natural regions to launch in. WFC has >10% deposit share in NE (AUM share appears to be higher) and BAC/WFC's ~43% deposit share in CA (wow!). I guess he could start on the east coast? On second thought, this proposal may be as ridiculous as suggesting BRK buyout MCO or something.

 

I may be missing something, but what are you talking about? What does bank deposit share have to do with Berkshire starting an investment advisor?

 

heavy invests in AU banks

 

Can you point me to the "heavy investments" in Aussie banks? I see none. I know they have reinsurance exposure to catastrophes there (and New Zealand) and I know they own Aussie sovereigns, but I don't know of a material investment in an Aussie bank.

 

As for the dividend, Berkshire shareholder would be no better off, at least in the short term since P/B > 1. Distribution of book leaves you with less, since the market values book @ 1.3-1.4.

 

I didn't like PCP either, but don't agree with anything you said.

 

EDIT: I googled around. Apparently he said he may want to buy some bank stock in Australia at some point when he did the deal with IAG. Is that "heavy" investing? What % exposure is there to Australia?

[Guest Schwab711]

there are some bizarre things in this post.

 

If it could be used to monetize their deferred tax assets then it would seem worthwhile.

 

Berkshire has a $63B deferred tax liability, not an asset. The goal is to not realize this. The best way to  "monetize" it is to do nothing.

 

Bad language. I probably could have waited until morning to post. Most of those deferred liabilities are due to a handful of holdings. There may come a point where it doesn't make sense for one or both of the insurance arms to hold [some or all of] these positions. If that occurs, it may not make as much sense for Berkshire, the conglomerate, to hold those positions. That's what I was trying to say. Berkshire is already using the name to gain share in reality. It wouldn't be a stretch to move into IA and it gives them an out in case of the above.

 

I assumed NE or CA would be the natural regions to launch in. WFC has >10% deposit share in NE (AUM share appears to be higher) and BAC/WFC's ~43% deposit share in CA (wow!). I guess he could start on the east coast? On second thought, this proposal may be as ridiculous as suggesting BRK buyout MCO or something.

 

I may be missing something, but what are you talking about? What does bank deposit share have to do with Berkshire starting an investment advisor?

 

Most banks have IA arms. There's readily available data on deposit share but it would take a lot of work to find actually IA market share data. It's a decent proxy.

 

 

heavy invests in AU banks

 

Can you point me to the "heavy investments" in Aussie banks? I see none. I know they have reinsurance exposure to catastrophes there (and New Zealand) and I know they own Aussie sovereigns, but I don't know of a material investment in an Aussie bank.

 

As for the dividend, Berkshire shareholder would be no better off, at least in the short term since P/B > 1. Distribution of book leaves you with less, since the market values book @ 1.3-1.4.

 

I didn't like PCP either, but don't agree with anything you said.

 

EDIT: I googled around. Apparently he said he may want to buy some bank stock in Australia at some point when he did the deal with IAG. Is that "heavy" investing? What % exposure is there to Australia?

 

They don't disclose. We have no idea if they even started investing in AU or not. Maybe I shouldn't have used a descriptor. "Heavy" was referrencing the % allocation of Australian investments only (as reported). Just an example of where Buffett has been investing lately. Your google search is what I was referring to.

[maxthetrade]

As long as Berkshire converts $1 in retained earnings into $1.x of market value it makes much more sense to retain earnings instead of converting $1 into $0.x of dividends. If you can find investments that compound faster just sell shares, what is so difficult to grasp about this concept?

 

[JBird]

If Berkshire compounds at 6% then you have:

• 7.1%
  
• 7.5%

 

I think it's possible and maybe likely that the majority of his shareholders could find at least one deal (maybe 1%-2% of their capital, assuming 100% allocation) with higher returns. I wouldn't have wrote this if I thought the floor for BRK was 10%.

 

Then why do you own the stock?

[Guest longinvestor]

If Berkshire compounds at 6% then you have:

• 7.1%
  
• 7.5%

 

I think it's possible and maybe likely that the majority of his shareholders could find at least one deal (maybe 1%-2% of their capital, assuming 100% allocation) with higher returns. I wouldn't have wrote this if I thought the floor for BRK was 10%.

 

Stick around with these thoughts for a few years!

[bookie71]

IF you want dividends then you must pick another stock.  Read WEB's letters and you will see that he won't pay dividends.

[shalab]

In the past five years, the EPS has grown at 15%/year, investments/share has grown @ 10%/year.

Let us say the growth goes to zero, i.e, no growth in 160K/share in investments and EPS sits at 12.5K/year. If the 160K/share yields 5% - we get 8K/share in returns pre-tax.

 

Just adding the two gives about 10% yield at today's prices assuming 0% growth.

 

Also, the odds of getting a dividend is zero as there was a shareholders vote recently and 98% voted not to have a dividend. WEB suggested you can get a low cost dividend by selling your B shares as you need income. It is more tax efficient than a dividend distribution. Also, Munger has said that the day Berkshire offers a dividend is a sad day - as it means the compounding machine is not working the way it used to.

 

Even if your assumption of 6% growth is likely to provide better returns than SP500 where a bunch of companies are providing "Proforma" or non GAAP earnings - e.g:, VRX's cash earnings which excludes a bunch of costs or Google's proforma earnings or Amazon's overstated cash flow.

 

If there is growth at 6%/year as you assume, then the return with retained earnings should be higher than 10% (at today's prices).

 

If Berkshire compounds at 6% then you have:

• 7.1%
  
• 7.5%

 

I think it's possible and maybe likely that the majority of his shareholders could find at least one deal (maybe 1%-2% of their capital, assuming 100% allocation) with higher returns. I wouldn't have wrote this if I thought the floor for BRK was 10%.

[scorpioncapital]

"lso, Munger has said that the day Berkshire offers a dividend is a sad day - as it means the compounding machine is not working the way it used to"

 

Every company should pay attention to this line as it reveals a cold hard truth. If you're paying dividends, unless there is some very specific tax reason, it almost certainly implies admitting a limitation on opportunity. Which is puzzling that some companies boast of dividend payouts for 50 or 100 years. To me this is a sign on your door that says we haven't been really hot for the better part of a century :)

 

 

[Guest longinvestor]

"lso, Munger has said that the day Berkshire offers a dividend is a sad day - as it means the compounding machine is not working the way it used to"

 

Every company should pay attention to this line as it reveals a cold hard truth. If you're paying dividends, unless there is some very specific tax reason, it almost certainly implies admitting a limitation on opportunity. Which is puzzling that some companies boast of dividend payouts for 50 or 100 years. To me this is a sign on your door that says we haven't been really hot for the better part of a century :)

 

+1. For Buffett and Munger it would be the ultimate white flag to pay a dividend or buy stock back. They would rather let the next guy in charge do it. This was kind of hinted at in the "next 50 years" commentary last year. They have been in the business of taking capital in, not returning it, for 50 years. If the market idiots force their hand by selling the stock back at <1.2x, oh well, they are idiots. 

 

There is also an unspoken issue with long term dividend payers. Stopping it. No one dare go there.Dividends should be one of several options for capital. It could be very stifling to intelligent allocation of capital for it be the first option, always. "Don't trust management" seems to be at work. If you are a shareholder and you want "your money back" because you think management will screw it up, why are you in the stock?

 

On the shareholder side, there seems to be a perverse psychology at work. That it is OK for your 100 share holding  to go down to 95 shares or 80 or 70 when you need the money. Would rather get that dividend. And leave management alone with  "divvie received, all is well with my 100 shares". No matter if the current price is 2x  or 5x cost basis. There seems to be anchoring around this. Has anyone else seen this? 

[scorpioncapital]

If you have a smaller country in which domestic shareholders pay zero tax on certain domestic dividends up to a certain bracket, I can see some justification, although only a small one. (Canada comes to mind) But otherwise, the theory should be that 90 shares without a dividend will increase in dollar amount by at least the difference in the dividend not paid on 100 shares paying that dividend. But dividends have been the greatest long term psychological trick in markets, for some reason everyone cares about it. For me, dividends are for the old(er) who want their income now or for the leveraged with fixed expense (like Berkshire investment holdings actually) that can leverage up the return with less consequence than most retail investors.

 

 

 

[bennycx]

I'll definitely take my money in a dividend.

 

Management are almost always 1) overconfident about their abilities to grow the company, 2) lousy at capital allocation or 3) don't really work for shareholders.

 

At least when dividends are distributed it gives them cash flow discipline. Otherwise all that excess cash flow will go into overpaying a big acquisition or a "growth" initiative.

[scorpioncapital]

"Management are almost always 1) overconfident about their abilities to grow the company, 2) lousy at capital allocation or 3) don't really work for shareholders."

 

Excellent points! The flip side argument might be why invest in said managements at all? Or an alternate theory: Can position/bet sizing of the stock have the same effect as dividend to guard against internal allocation risk?

 

 

[Greg]

  If you want a dividend in any amount you can create it and have a tax advantage.

  If, for example, you want a 3% dividend you can sell 3% of your stock each year. You will have a tax advantage over Berkshire paying the dividend unless your cost basis is 0.

  If you do not create a dividend because you think the stock will be worth more in the future, by a value exceeding the dividend, then you have answered the question and voted for Berkshire not paying a dividend.

[bennycx]

"Management are almost always 1) overconfident about their abilities to grow the company, 2) lousy at capital allocation or 3) don't really work for shareholders."

 

Excellent points! The flip side argument might be why invest in said managements at all? Or an alternate theory: Can position/bet sizing of the stock have the same effect as dividend to guard against internal allocation risk?

 

Sure, but it is not so simple like that.

 

A company paying a consistent dividend vs one not paying a dividend when it can impacts the psyche of management.

 

Management becomes overconfident of its ability to grow the company looking at the excess cash flow it has and proceeds to continue, overpaying finally for further acquisitions. Paying a dividend disciplines this management team. They could be good people or trying their best to reward shareholders, but they are still humans, affected by behavioural biases.

 

This is akin to putting every month X% of your salary into an index fund vs accumulating a ton of money and trying to "time" the market.

 

Also one more point: most management teams get there because they're good operators, not capital allocators. I'd rather them run the company efficiently or grow the company with some creative marketing ideas with LESS money to play around.

[scorpioncapital]

You know it's discussions like this that can really accelerate one's investment learning. This analysis of dividends runs from A to Z to what it means to invest in a company, what a management should do, what investing is, what business is. It's the opposite of the casino approach that is sometimes played in markets!

[Guest longinvestor]

"Management are almost always 1) overconfident about their abilities to grow the company, 2) lousy at capital allocation or 3) don't really work for shareholders."

 

Excellent points! The flip side argument might be why invest in said managements at all? Or an alternate theory: Can position/bet sizing of the stock have the same effect as dividend to guard against internal allocation risk?

 

Sure, but it is not so simple like that.

 

A company paying a consistent dividend vs one not paying a dividend when it can impacts the psyche of management.

 

Management becomes overconfident of its ability to grow the company looking at the excess cash flow it has and proceeds to continue, overpaying finally for further acquisitions. Paying a dividend disciplines this management team. They could be good people or trying their best to reward shareholders, but they are still humans, affected by behavioural biases.

 

This is akin to putting every month X% of your salary into an index fund vs accumulating a ton of money and trying to "time" the market.

 

Also one more point: most management teams get there because they're good operators, not capital allocators. I'd rather them run the company efficiently or grow the company with some creative marketing ideas with LESS money to play around.

 

Agree with your point about operators versus allocators. There are very, very few good allocators. Leaving operators to operate has a lot of wisdom. You just described the new, ever-larger Berkshire of today and tomorrow. And the rationale behind Buffett's role getting split into two when he is no longer in charge. And a likely return of capital with the passage of time.  But it will very likely be done in the most rational way from the shareholder's perspective.