Warren Buffett is very clear about the features he favors in a stock. One feature he’s always praising is dividends.
There are many things to love about dividends; dividends demonstrate management’s commitment to shareholders, and they imply a company that’s mature and making more money than it needs to function. For individual investors, dividends provide an attractive passive revenue stream.
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For Buffett, there’s an extra layer of complexity because earnings get plowed back into Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) and provide money for other parts of the business, increasing the total value of the company.
So it might seem ironic that Berkshire Hathaway does not pay dividends itself. However, Buffett hasn’t said that the company would never pay dividends; in fact, he outlined when he thought that might happen. Here’s what he said.
Why doesn’t Berkshire Hathaway pay a dividend?
Buffett loves dividends, but he’s explained many times why his company doesn’t pay them. “Not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years,” he said in 2011. He continued:
Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about $1 billion per month. Our net worth has thus increased from $48 million to $157 billion during those four decades, and our intrinsic value has grown far more. No other American corporation has come close to building up its financial strength in this unrelenting way.
Image source: Getty Images.
That’s just one glimpse in time of what reinvesting earnings into the company has done for the company itself and for shareholders. In fact, the very reason Buffett loves dividends from his equity investments is the money that gets poured into the company and adds to its total value and asset-earnings potential. I don’t think Buffett would suggest that any company capable of that should pay dividends, but he might not find any other companies that fit the bill.
Payment of dividends was voted on by shareholders in 2014, and it was turned down by 98% of voters, with Class A shareholders declining by 89 to 1 and Class B shareholders voting it down by 47 to 1. “To have our fellow owners — large and small — be so in sync with our managerial philosophy is both remarkable and rewarding,” Buffett said at the time.
Is this about to change?
Buffett has already set out the parameters for when it might be time for Berkshire Hathaway to start paying dividends. In this 50th annual letter, when giving an analysis of the previous 50 years, this is what Buffett said:
Eventually, probably between ten and twenty years from now, Berkshire’s earnings and capital resources will reach a level that will not allow management to intelligently reinvest all of the company’s earnings. At that time our directors will need to determine whether the best method to distribute the excess earnings is through dividends, share repurchases or both. If Berkshire shares are selling below intrinsic business value, massive repurchases will almost certainly be the best choice. You can be comfortable that your directors will make the right decision.
Where is Berkshire Hathaway holding today, 10 years later? It has its highest-ever cash stockpile, which is nearly six times what it was when Buffett wrote this, and Buffett is stepping down. With nearly $348 billion in cash, a figure that has been growing for more than two years, it doesn’t look like he or his team is finding a tremendous number of opportunities to intelligently invest Berkshire’s capital. And net income is at a staggering level.
BRK.B Net Income (TTM) data by YCharts
At the same time, its price-to-book value ratio has been climbing.
BRK.A Price to Book Value data by YCharts
Berkshire Hathaway has historically been management’s favorite stock to buy, but it hasn’t repurchased shares in the past three quarters; it sees more value in holding on to cash. So it looks like, at least according to the way Buffett set it up, dividends might be on the way.
Don’t expect any huge changes
On the other hand, Berkshire Hathaway’s incoming Chief Executive Officer Greg Abel may not be so fast to institute dividends.Abel is well trained in Buffett’s path, and he’s unlikely to make any major shakeups. This doesn’t look like the typical case of a new CEO being brought in who’s looking to make his mark or make changes to a failing company. Abel has been with Berkshire Hathaway for more than 25 years, he’s been hand-picked as Buffett’s successor because his management style is similar to Buffett’s, and Berkshire Hathaway is the very opposite of a failing company.
That said, the earlier arguments about what would need to be in place for Berkshire Hathaway to start paying dividends, along with Berkshire Hathaway entering a new era of leadership, make it seem like dividends are a plausible next step, if not actually a given.
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Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
