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Should Berkshire pay a dividend?


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Someone posted this on Yahoo and thought it made a lot of sense:

 

Retained earnings Dec 2003: 31.9 bil

Retained earnings Dec 2008: 78.2 bil

Five-year change in retained earnings: 46.3 bil

 

Stock market value Dec 31, 2003: 84,250*1.54 = $129.7 bil

Stock market value Dec 31, 2008: 96,600*1.55 = $149.7 bil

Five-year change in market value = 20.0 billion

 

In the owner's manual, Buffet says that every 5 years this test should be met or a dividend should be considered. It hasn't been met for 2008 and also hasn't been met so far in 2009. Berkshire stock would have to rise 45% in the next 6 months for the test to be met. Is Buffet wrong in not paying a dividend?

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I do not think this is a good test. Yes, it provides a quantitative check on intentions but it is a way of "using the market to inform you rather than to serve you".

 

A better test would be "Has the intrinsic value increased by at least as much as the amount of retained earnings". I think the answer to this questions would be a resounding yes.

 

Vinod

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I do a somewhat similar check for stocks over 10 year periods, but I try to check how much earnings have increased as a result of retained earnings rather than use the market values. A stock can start the measure period at an expensive level and end the period deeply undervalued, in which case it fails this test.

 

Vinod

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Guest Bronco

Here is the real test...can you invest the dividend (allocate capital) better than Warren Buffett?

 

And if you don't own Berkshire Hathaway in a retirement account - can you invest $85 (assuming 15% dividend tax) better than Warren Buffett can invest $100.

 

If the majority of the shareholders can answer "Yes" to the above, then BRK should pay a dividend.

 

 

Personally, after Warren pulled the pants down on Blankfein and Immelt, I would rather he keeps the capital.

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I'll not talk about if Berkshire should pay a dividend or not, but you ask a good question.

 

Well, if he consider it to be a good measurement stick enough to write it in the Owner's Manual, I 'm sure he believes that it is useful to use it. And if not, it would be silly to do that and Buffett is VERY FAR from being silly. It would be like to write yourself a norm that say "If I don't run 100 meters in 11 seconds, I'll have to stop eating hamburgers" and then, when you get 13 seconds, say "Well, that norm was bull**** and I'll keep eating hamburgers"

 

It would be a relevant question to ask at the next AGM or for a student to do so in one of the Buffett meeting.

 

 

 

 

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At this point, the question of "should he or shouldn't he" is largely academic....it's now a question of "can he safely do it?" 

 

On behalf of shareholders, Buffett has deployed a ridiculous amount of capital over the past 18 months.  The cash hoard is much reduced and has been replaced by GS converts, HOG bonds, GE converts, etc.  With the bargains that were available in February and March IMO, the only reason why we haven't seen more capital deployed is that WEB wants BRK to be the Rock of Gibraltar. 

 

The fact that he didn't blow off more cash in March to buy equities indicates you can be pretty sure that there ain't gonna be a dividend.

 

SJ

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Like everything else in life, it depends.    I personally will not invest in companies that do not pay divs except for the occasional small cap speculation play.  It's not always a question of can you invest the money better, many of us believe that an investment that doesn't produce cash flow is not an investment at all.

 

In Berkshire's case, if the majority of shareholders do not want a dividend, that is their prerogative, but your "investment" is then completely dependent on whether someone else is willing and able to buy your shares from you at a future date.  It seems like everyone would be better served by paying a dividend, and then those who want to can reinvest.

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Here is the real test...can you invest the dividend (allocate capital) better than Warren Buffett?

 

I think that is the purpose of the test in the owner manual, that good capital allocation should convert into an equivalent increase in market price, if it doesn't, you can't benefit from the good capital allocation. Essentially, the market must be inefficient on Berkshire stock. If Berkshire retained $40 billion and the market price went up zero, then the market price should go up $40 billion. What I think is happening is multiple to book value compression, which is not good at all. Essentially, not only you are not getting $1 of increased market value for $1 of retained earnings you are getting a decrease of 1/2 of market value for $1 of retained earnings.

 

 

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Guest Bronco

Santayana,

 

With all due respect, I can't imagine what Berkshire Hathaway would look like had capital constantly been taken out of the company via dividends.  I hear your point as it applies to other companies, but I would respectfully disagree w/ BRK.

 

Scorpion Capital - maybe the "test" is obsolete.  Let's be honest - Buffett probably knows that capital kept within Berkshire Hathaway is the best possible scenario for shareholders.  Buffett can do deals (GE, Mars, GS, etc) that a normal shareholder wouldn't have access to.  And most shareholders should be gracious - Buffett kept tons of cash during the five year run up before the crash.  If that money would have been distributed, most shareholders would have invested the cash and lost money on practically all investments.

 

I think the real "test" in paying dividends is currently based on the comparison of if a a dollar worth more in BRK or worth more if distributed.  Again, I challenge any shareholder to prove that they can produce higher returns from a $85 base versus Buffett starting at a $100 base.  Not likely.

 

I understand the dividend debate, and I like the discussion, but I am a little surprised that people always challenge Buffett on a formula that has surpassed all others.  Generate Capital.  Maintain Capital.  Allocate Capital to the best source.  Invest in opportunities to increase float, producing more investable capital.  Etc. Etc.

 

 

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And the winner is.......:  Bronco.  Good logic.    ;D

 

When the clouds of fear, doubt and confusion clear, brk's market value will pop back up to where it belongs. Should not take too long.

Nice little arbitrage opportunity though.

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I personally hope Berkshire does not become dividend-paying stock.  It complexifies the taxation for many non-US investors, depending upon their own country's rules for foreign dividends.  Would change the compposition of the shareholder base.

 

And the case for letting Buffett (& successors) carry on is also compelling.  They're doing great job!  Don't let theory trump performance.

 

I think the owner's manual paragraph could use some clarification, maybe next annual letter he will discuss / revise?

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I do not think this is a good test. Yes, it provides a quantitative check on intentions but it is a way of "using the market to inform you rather than to serve you".

 

A better test would be "Has the intrinsic value increased by at least as much as the amount of retained earnings". I think the answer to this questions would be a resounding yes.

 

Vinod

 

i agree with vinod.

 

although using book val as a proxy for intrinsic val is an admittedly very imperfect method when dealing with a collection high ROE businesses, its still a decent simplistic measure. and an investor has to then decide for themselves whether or not book val overststes or understates intrinsic val. looking at annualized the earnings increases in brk's non inisurance ops over the last 10 yrs, i think brk's intrinsic val has increased more.

 

 

that said, i am no longer a big owner of brk like i had been for many yrs in the past...its just simple math...its gotten too big.

 

 

never the less, i dont know how these no.'s can fail to impress:

 

<<Annual Percentage Change

in Per-Share in S&P 500

Book Value of with Dividends Relative

Berkshire Included Results

Year (1) (2) (1)-(2)

 

2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21.0 28.7 (7.7)

2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.5 10.9 (.4)

2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.4 4.9 1.5

2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18.4 15.8 2.6

2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.0 5.5 5.5

2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9.6) (37.0) 27.4

 

The following tables illustrate this shift. In the first we tabulate per-share investments at 14-year

intervals. We exclude those applicable to minority interests.

Year

Per-Share

Investments

Years

Compounded Annual

Gain in Per-Share Investments

1965 $ 4

1979 577 1965-1979 42.8%

1993 13,961 1979-1993 25.6%

2007 90,343 1993-2007 14.3%

For the entire 42 years, our compounded annual gain in per-share investments was 27.1%. But the

trend has been downward as we increasingly used our available funds to buy operating businesses.

Here’s the record on how earnings of our non-insurance businesses have grown, again on a pershare

basis and after applicable minority interests.

Year

Per Share

Pre-Tax Earnings

Years

Compounded Annual Gain in Per-

Share Pre-Tax Earnings

1965 $ 4

1979 18 1965-1979 11.1%

1993 212 1979-1993 19.1%

2007 4,093 1993-2007 23.5%

For the entire period, the compounded annual gain was 17.8%, with gains accelerating as our

focus shifted.>>

 

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I don't have a job and I need cash to fund the cost of living.  In a position such as mine, once the portfolio generates enough income to fund all of my expenses, I can then truly say that I care not what Mr. Market does.

 

A dividend is a way of incrementally tapping my portfolio's intrinsic value at 100%, and Mr Market can't get in the way.  A no-dividend policy simply means that I can only tap the intrinsic value of my investments at the 100% level only when Mr. Market says so.  And that might never happen.

 

Another thing to consider is that if size is the anchor of performance, why get bigger?  Paying a dividend might, in theory, improve the returns of the capital left behind. 

 

Then there are the people with jobs that don't want extra income -- they perhaps care not about the dividend.  Or the people with so much money that they don't need more income -- they might like a no-dividend policy as a way of tax reduction.

 

There is no best answer.  Different strokes for different folks.

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