Updated on October 31st, 2019 by Josh Arnold
Berkshire Hathaway (BRK.A) (BRK.B) is one of the most successful companies in American history. The story began when world-famous value investor Warren Buffet began buying shares in an ailing textile manufacturer in the early-1960’s. He eventually purchased enough shares to take over control of the company, and began investing its cash. The rest is history as Berkshire has become one of the most valuable companies in the world, with an enormous investment portfolio.
Berkshire’s vast and diverse portfolio contains discretionary consumer brands, consumer staples, manufacturing businesses, railroads, insurance, energy companies, utilities, and others. Over time, it has built an enviable position that capitalizes on economic growth in a variety of ways.
For investors, Berkshire has many of the characteristics of a great investment – a wide economic moat, a strong track record, and a management team that recognizes the value of taking care of shareholders. The only thing missing is a dividend.
The problem is that Berkshire doesn’t believe in paying dividends, owed to Buffett’s own aversion to doing so. Berkshire Hathaway is the furthest thing from a Dividend Aristocrat, an exclusive group of 57 stocks in the S&P 500 Index with 25+ years of annual dividend growth.
You can download an Excel spreadsheet of all 57 (with metrics that matter) by clicking the link below:
However, given the 57-year reign of Warren Buffett at the top of the company, investors might wonder if this hard line policy of no dividends will change when he eventually steps down. The “Oracle of Omaha” is 89 years old and at some point, will have to step down as Chairman and CEO.
Will this be enough for Berkshire to pay a dividend, breaking Buffett’s promise that Berkshire won’t pay a dividend?
Understanding Berkshire’s No-Dividend Policy: The Buffett Factor
Berkshire Hathaway trades with a market capitalization of $523 billion, and produces about $65 billion in annual revenue. Its revenue comes from an enormous variety of subsidiaries, wholly-owned and otherwise, as well as the company’s diverse and massive equity portfolio. Berkshire has its core insurance subsidiaries like GEICO, General Re, and Berkshire Reinsurance, as well as wholly-owned subsidiaries like Duracell, Fruit of the Loom, Precision Cast Parts, See’s Candies, Dairy Queen, and a host of others.
Of course, Berkshire also owns tens of billions of dollars’ worth of publicly-traded stocks like its sometimes decade-long positions in companies like Coca-Cola (KO), American Express (AXP), Apple (AAPL), and Wells Fargo (WFC). Berkshire has ended up with so much investable cash over the years it couldn’t profitably put it back into its own businesses. This led to enormous sums of money being invested on the company’s closely watched publicly-traded portfolio.
Berkshire Hathaway management isn’t shy about its distaste for dividends:
“The question is about evaluating Berkshire when it doesn’t pay any dividends. 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.”
– Warren Buffett
Before explaining why Berkshire’s dividend policy may change in the future, it is useful to understand why the company currently pays no dividend. The principal reason why Berkshire doesn’t return cash to shareholders via dividends is because Buffett doesn’t believe that is a good use of cash. While investors may look at the company’s cash generation and wonder why it cannot spare some for shareholders, investors would do well to remember Buffett is one of the most successful investors of all-time. He’s taken a failing textile manufacturer and turned it into a company that is worth more than half a trillion dollars over a nearly six-decade career.
If Berkshire were to pay a dividend, every dollar of dividend payments received by shareholders would one dollar fewer being managed by Buffett. Unless investors believe they can outperform Warren Buffett, dividends are detrimental to total returns as a shareholder of Berkshire Hathaway.
Buffett understands this, and he is against dividend payments as a result. For instance, when asked about Berkshire’s single historical dividend payment (which occurred in 1967), Buffett joked that he “must have been in the bathroom” when the decision was made.
However, Buffett is 89 years old, and thus will eventually be replaced as CEO of Berkshire, potentially in the not-too-distant future. There’s a chance Buffett institutes a dividend even before he leaves Berkshire. Here’s another quote from Buffett (the 5-year test below is referencing whether to retain earnings or pay dividends):
“The five-year test should be:
(1) during the period did our book-value gain exceed the performance of the S&P; and
(2) did our stock consistently sell at a premium to book, meaning that every $1 of retained earnings was always worth more than $1? If these tests are met, retaining earnings has made sense.”
Berkshire hasn’t always passed part one of the above test, but in the period of 2014 to 2018, the company has beaten the broader market:
- Berkshire’s book-value-per-share compound growth rate: 9.8%
- The S&P 500’s annualized total returns: 6.5%
It is worth noting that the S&P 500 has vastly outperformed Berkshire so far in 2019, which largely closes the above gap. However, Berkshire’s book value has compounded at an average rate of 18.7% since 1965, which is astounding. This is why Buffett believes he can always find a better use for cash than to simply pay it out to shareholders.
For investors that want to see a cash dividend from Berkshire, there appears to be some hope. The company has publicly stated that Buffett’s role will be split up upon his departure. The management of Berkshire’s investment portfolio will likely be entrusted to a group of individuals, while the CEO and Chairman roles will be assumed by another, or possibly, two individuals.
Berkshire has appointed two portfolio managers already, who have managed ever-growing sums of Berkshire’s capital. These individuals are Todd Combs and Ted Weschler, two ex-hedge fund managers personally selected by Buffett.
The company has also internally identified at least one successor to Buffett’s executive role. Some investors have questioned whether this candidate will change Berkshire’s dividend policy.
While it may take some time after Buffett steps down for a dividend to be initiated, one cannot help but draw comparisons to Apple, which had a similar stance to dividends when Steve Jobs was at the helm. Jobs was running Apple during its darkest times when it nearly went out of business, and he never moved past hoarding cash in a sort of “rainy day” fund, regardless of the company he built eventually becoming the most valuable in the world. Jobs didn’t believe in paying dividends under any circumstance, but today, Apple returns tens of billions of dollars of cash to shareholders each year.
Buffett is in a similar spot. He runs one of the most successful companies in the world, and it generates enormous amounts of cash it doesn’t need for capital expenditures and the like. When Buffett is out of the picture at Berkshire, depending on who takes over, Berkshire could very easily afford to pay a meaningful dividend. Whether this will happen or not remains to be seen, but the comparison to Apple is striking, and provides at least some measure of hope to dividend investors.
Berkshire: The Cash Factor
Another factor that has led investor to question the possibility of dividends is the tremendous amount of cash and equivalents on Berkshire’s balance sheet. Because of Berkshire’s strong operating performance, the company is sitting on more cash than ever before, and it grows every year, barring huge acquisitions, which Berkshire does from time to time.
Today, Berkshire’s cash hoard is in excess of $119 billion. Buffett prefers to keep about $20 billion of cash on hand in case some serious insurance claim needs to be paid, which gives $99 billion of cash available for acquisitions or internal investment. This is in addition to the $200 billion equity portfolio, as well as another $20 billion in fixed term investments. In other words, Berkshire has an enormous amount of capital available that is highly liquid.
In addition, Berkshire produced $16.8 billion in operating cash flows in the first half of 2019, implying ~$33 billion in operating cash flow annually. Capital expenditures were less than $7 billion in the same period, so Berkshire has potentially ~$20 billion annually it can invest, or eventually return to shareholders.
Dividend payments would certainly help to reduce these numbers, allowing Berkshire’s investors to deploy this capital at a higher return than the money market rates that Berkshire is earning on its cash and equivalents. Berkshire is heavily invested in short-term Treasuries with its cash equivalents, so returns are quite low on these billions of dollars.
However, this alone isn’t necessarily enough for Berkshire to initiate dividend payments. After all, the company has been adept at deploying capital in the past, so it could simply be waiting for the next big acquisition opportunity. In addition, there are other companies that can afford a dividend, but choose not to pay one.
Berkshire: The Size Factor
Berkshire is so huge today that it has become difficult for the company to identify acquisition opportunities large enough to move the needle on its cash pile. The conglomerate has a current market capitalization of ~$523 billion. Also, remember that the company has $119 billion of cash and equivalents on its balance sheet.
To deploy any meaningful proportion of Berkshire’s capital, the company’s management will have to target very large acquisitions. This creates a situation where the company has so much cash, it can become difficult to profitably invest it all, which we believe is why there is so much cash sitting essentially idle on the balance sheet.
As Berkshire grows and such acquisitions become necessarily larger, it becomes likelier that the company will begin paying a dividend. The reason is because, like Apple, Berkshire is in a position where it cannot spend all of the cash the company generates, and this is exactly the situation where companies begin returning cash to shareholders. After all, if the cash is earnings 1% or 2% in short-term Treasuries, why not return it to shareholders?
Buffett has made it clear he has no intention of paying cash dividends to shareholders, but in recent years, the company has moved the needle a bit on shareholder returns, which perhaps bodes well for a future dividend payment. Berkshire buys back its own stock when certain valuation conditions are met, and the float has been marginally reduced in recent years as a result. While this is nowhere near a full capital return program, the fact that Buffett was willing to return any capital to shareholders is, our view, a positive development for eventually paying a dividend.
Berkshire Hathaway appears more likely to pay a dividend when Warren Buffett retires than at any other time in its history.
Combining Buffett’s retirement with the company’s growing size and even-faster-growing cash pile, it might seem like dividends are all but a sure thing for the Berkshire Hathaway investors of the future.
Still, we remain skeptical that the company will pay a dividend in the near future because Buffett is still in control, and because wholesale changes in capital allocation strategy – particularly one that has been ingrained in a company’s culture for nearly 60 years – are difficult to implement. In Apple’s case, the company began paying dividends just a year after Steve Jobs passed away, so there is some precedence for such a turnaround in philosophy. We don’t necessarily think Berkshire will return cash to shareholders that quickly, but we also wouldn’t rule it out completely.
The Oracle of Omaha has spent half a century building today’s Berkshire. However, at some point, Berkshire’s cash pile will simply become too large to manage. It is at that point that we see Berkshire considering a dividend.
The company will still have outstanding investment managers. Further, although it hasn’t publicly identified attractive acquisition targets lately, Berkshire has shown the desire and ability to make substantial acquisitions when the right opportunities come along.
For these reasons, we remain doubtful Berkshire will initiate a dividend for the foreseeable future.