Berkshire Hathaway, Inc. (NYSE:BRK.B) has paid out a dividend just once under Warren Buffett’s watch, a $0.10-per-share payout in 1967. Buffett later joked, “I must have been in the bathroom when the decision was made.”
But no one’s joking anymore. “A number of Berkshire shareholders — including some of my good friends — would like Berkshire to pay a cash dividend,” Buffett said in his latest letter to shareholders.
Who’s going to win this battle?
In 1998, a student at the University of Florida asked Buffett about dividends. Buffett repeated the question for the crowd. “The question is about evaluating Berkshire Hathaway, Inc. (NYSE:BRK.B) when it doesn’t pay any dividends,” he said. “And it won’t pay dividends, either. That’s a promise I can keep. All you get with Berkshire stock is that you can stick it in your safe deposit box, and every year you take it out and fondle it. “
So there’s that.
But the question keeps popping up. It has become almost ritualistic for a shareholder to ask Warren to pay a dividend at its annual shareholder meeting in Omaha.
In the latest letter to shareholders, Buffett brought up a great rebuttal. You want a dividend? Make one yourself by selling some of your fondled stock certificates. You get the cash you wanted, and it’s far more efficient than Berkshire Hathaway, Inc. (NYSE:BRK.B) paying an actual dividend.
Buffett used an example of a small business with two shareholders. Imagine a business worth $2 million and earning $240,000 a year. Shares are worth 125% of book value on the open market. Profits can be reinvested back into the business and earn 12% per year, but the two owners want some cash to pay their bills, and opt to take one-third of the company’s profits out as a dividend every year.
After 10 years the two owners would own shares worth $2.7 million each, and pull in dividends worth $86,000 per year. “And we would live happily ever after — with dividends and the value of our stock continuing to grow at 8% annually,” Buffett writes.
But another option is available to the two owners:
Under this scenario, we would leave all earnings in the company and each sell 3.2% of our shares annually. Since the shares would be sold at 125% of book value, this approach would produce the same $40,000 of cash initially, a sum that would grow annually. Call this option the “sell-off” approach.
Under this “sell-off” scenario, the net worth of our company increases to $6,211,696 after ten years ($2 million compounded at 12%). Because we would be selling shares each year, our percentage ownership would have declined, and, after ten years, we would each own 36.12% of the business. Even so, your share of the net worth of the company at that time would be $2,243,540. And, remember, every dollar of net worth attributable to each of us can be sold for $1.25. Therefore, the market value of your remaining shares would be $2,804,425, about 4% greater than the value of your shares if we had followed the dividend approach.
Moreover, your annual cash receipts from the sell-off policy would now be running 4% more than you would have received under the dividend scenario. Voila! — you would have both more cash to spend annually and more capital value.