It’s a well known fact that Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) has only paid a dividend once in its history. Buffett is a strong believer in the idea that dividends should only be paid out if that cash can’t be more efficiently reinvested in the business.
Since Buffett is rightly considered to be one of, if not the, most effective capital allocators in financial history, it makes sense that Berkshire doesn’t pay dividends. But what about the companies that Buffett likes as investments?
At the 1995 Berkshire Hathaway annual investor conference, the Oracle of Omaha explained his position on dividends paid by companies that he is invested in.
To return or not to return?
Buffett was asked by a shareholder whether he would like to see companies like Coca-Cola (KO, Financial) or Gillette (now owned by Procter and Gamble (PG, Financial)) withhold the cash that they pay out to their investors in the form of dividends. Buffett replied:
“It depends on how they could utilise their cash - those are more focused enterprises than Berkshire. I commend management that has a wonderful business for utilising cash in those businesses and for giving the rest of the money to the shareholders. So Coca-Cola in my book is doing exactly the right thing with its cash. It uses all the cash in its business effectively to expand into new markets, returns money to shareholders and then repurchases shares in a big way, which returns cash to shareholders on a selective basis, but in a way that benefits all of them.”
Buffett says that Berkshire will retain cash for as long as it can redeploy it more effectively within the business and grow shareholder value at a higher rate than investors would get by receiving dividends. The core point that he was making is that even though Coca-Cola was returning dividends to shareholders, they were using the same logic that Berkshire does.
They utilise their cash flow in as most efficient way as possible - if they can grow the company effectively by building more bottling plants, they will do that. If they can’t, they will give money back to shareholders. There’s no contradiction between Buffett’s policy of not paying dividends from his holding company and the policy of companies he invests in to do so.
In short, a management team that retains shareholder money should only do it if it can create more than $1 dollar of shareholder value for every $1 it keeps. Any other course of action is unfair to the shareholders, who are the ultimate owners of the company.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Howard Marks: Will Algorithmic Investing Beat Out Humans?
- The Value Investor’s Handbook: Understanding Return on Capital Employed
- Buffett, Munger Explain the Most Important Metric to Look for When Investing
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