While Buffett did spend nearly 3 pages of his 24-page missive talking about dividends and capital allocation—making it clear that he likes receiving dividends on Berkshire’s investments—paying a dividend still isn’t on his agenda.
This reaffirmation of the status quo shouldn’t surprise anyone. Since Buffett took control of a then-struggling textile manufacturer in 1964, Berkshire has paid a dividend only once: $0.10 in January 1967 on each of
what are now the Class A shares (which recently traded around $155,000 apiece). Buffett has since joked that he must have been in the bathroom when the board voted to make that payout, but a lack of dividends certainly hasn’t hurt Berkshire’s long-term performance. Indeed, the profitable deployment of retained earnings has been an essential driver of
Buffett’s outstanding record.
My long-standing view is that all companies that can pay dividends—meaning those with the established profitability and financial strength to do so—should pay dividends. It’s not just that many shareholders want and deserve a cash return on their investment,
but the fact that virtually no company is capable of reinvesting all of its internally generated resources at adequate rates of return. In this context, Berkshire is the exception that proves the rule. Thanks to his extraordinary talents and a virtually unlimited opportunity set, Buffett has demonstrated an ability to deploy Berkshire’s ample earnings at superior returns.
That being said, I think it would be a big mistake for the managers and investors in any other company to conclude that dividends are unimportant, much less undesirable. Every other business on earth is supervised by a less capable allocator of capital, and not every investor seeks the same kind of investment result that Berkshire offers today. So when Buffett goes on to suggest that Berkshire shareholders should sell off shares rather than seek a dividend, I sincerely hope that investors in other companies— as well as those firms themselves—ignore his advice
Buffett identifies four choices that are available for a company’s internally generated resources: internal reinvestment, acquisitions, share repurchases, and dividends...
Buffett’s top priority is internal reinvestment—the deployment of capital back into existing businesses at good rates of return. I have no qualms with this priority whatsoever. Let’s say General Mills GIS is choosing between (1) spending $10 million on a new product line that should generate $2.5 million worth of annual aftertax earnings and (2) paying an
extra $10 million in dividends. Assuming the expansion project has a good chance of being successful, keeping the $10 million inside the company where it can earn a 25% return on capital is obviously the better choice. Among other factors, this expansion project would allow General Mills to raise its annual dividend outlay by $2.5 million a year forever, a result whose value dwarfs a one-time payout of $10 million. If shareholders instead received that $10 million as a one-off payment, it’s highly unlikely they could all duplicate the same 25% return on capital.
The problem with these opportunities—as Buffett readily acknowledges—is that they are generally finite. General Mills can (and does) innovate new products that command higher prices and profit margins; it can nibble (and has nibbled) away at the market share of its rivals; it can (and does) look to reduce costs. But people are only going to eat so much and
are only going to spend so much on the food they eat, and there’s a limit to how much market share General Mills can grab before inviting a harsh competitive response. Once General Mills has eaten through the
projects with 25% returns, 15% returns and 10% returns, the rest of the cash needs to go elsewhere or shareholder value will be destroyed.
With hundreds of diverse business lines, Berkshire has a much broader array of internal investment opportunities than General Mills does. Profits don’t have to stay within any one line of business; Buffett can deploy the excess earnings of See’s Candies into new locomotives at BNSF or a new store for Nebraska Furniture Mart. (Please, Mr. Buffett, ask the Blumkins
to open one in Illinois!) Yet Berkshire, like the vast majority of well-established businesses today, can hardly help but generate more cash than it can put back to work internally at acceptable rates of return.
Acquisitions are Buffett’s second-favorite venue for deploying retained earnings. His record on this front is excellent—one of the best ever. In his 1984 shareholder letter, in which he also discussed Berkshire’s dividend policy, he pointed out that paying dividends in his early days at Berkshire could have been disastrous. Only by redeploying capital out of dying
businesses like textiles and trading stamps could Berkshire have survived, let alone thrived But Buffett’s acumen as an acquirer—as well as his
position—is unique. Unlike your typical CEO, he buys entire companies with the mentality of an investor, not as an empire builder looking for a fatter pay packet. Elsewhere, a variety of academic research suggests that anywhere from 50% to 90% of mergers actually destroy shareholder value.
