The world’s greatest investor of all time, Berkshire Hathaway [(NYSE:BRK.A) (NYSE:BRK.B)] Chairman Warren Buffett, has a real distaste for dividends. It may surprise you to hear that. But it's 100% true. Now, the Oracle of Omaha doesn't mind receiving dividends. But Berkshire Hathaway has never paid a dividend. And it won't ever pay one, at least while Buffett and partner Charlie Munger are running the show.
I was re-reading Buffett's latest annual letter to shareholders during my recent vacation at the Oregon coast. I've been a Berkshire Hathaway shareholder for several years, and have the utmost respect for Buffett's value investing prowess. As you also know, I'm also a devoted income investor. It gives me great pleasure to receive sizable and growing dividend checks from my stocks (and to reinvest those dividends to buy more shares every quarter).
Everyone knows that Berkshire Hathaway doesn't pay a dividend. For this reason, many older investors and retirees who are living on a fixed income mistakenly overlook the stock. In his latest letter, Buffett responds to pressure from investors who want the company to initiate a dividend. After all, the diversified holding company is a true cash cow. In the last year, Buffett's company generated cash flow of $12.5 billion. That means more than $1 billion in positive cash is flowing into Omaha every month. There is plenty of cash to be paid to shareholders, if management thought that was the best decision.
But Buffett and Munger feel otherwise.
Of course, Berkshire benefits by receiving dividends from its sizable investments in public companies and dividend payers, including Coca-Cola (NYSE:KO), ConocoPhillips (NYSE:COP), and Wells Fargo (NYSE:WFC). But when it comes to Berkshire's balance sheet, the duo instead prefers to keep the cash and make additional investments, including outright acquisitions and individual stocks. The reason is simple: track record. Buffett and Munger have the best long-running investment track record. With Berkshire, you're essentially investing with the best allocators of capital.
As a Berkshire shareholder, I know that the managers will make good investment decisions for the long term. If I felt otherwise, I would simply sell the stock. Therefore, taking money off the table by way of a cash dividend would be a mistake. If the company started paying a dividend, I would be missing out on the future profits.
Since Berkshire has no plans to pay a dividend, Buffett offers up a different strategy for income investors. He calls it the "sell off strategy." And he's personally using this to fund his philanthropy. Buffett's advice is this: If you want income from Berkshire, simply sell a small portion of your stock holdings every year. By doing so, you can put cash in your account when you need it.
There are several specific benefits. First, investors who don't want a dividend check and don't need the cash won't receive one. Second, Buffett argues that there's a tax disadvantage to dividends. That's because 100% of dividends received are taxed. Meanwhile, if an investor sells stock at a profit, only the capital gain is taxed. And third, for investors not needing the cash flow, Berkshire will keep reinvesting the profits. If the historical record is a sign of things to come, those investments will be sound and the value of the stock will continue rising.
Buffett concludes his discussion of dividends, writing:
Most companies pay consistent dividends, generally trying to increase them annually and cutting them very reluctantly. Our 'Big Four' portfolio companies follow this sensible and understandable approach and, in certain cases, also repurchase shares quite aggressively.
We applaud their actions and hope they continue on their present paths. We like increased dividends, and we love repurchases at appropriate prices.
At Berkshire, however, we have consistently followed a different approach... We will stick with this policy as long as we believe our assumptions about the book-value buildup and the market-price premium seem reasonable. If the prospects for either factor change materially for the worse, we will reexamine our actions.
At the end of the day, Buffett has built Berkshire into something truly unique. It's a lean and agile company that owns outright hundreds of the best businesses, big and small. Plus, it has a unique and diverse investment portfolio of individual stocks and bonds.
Perhaps most importantly, Berkshire is committed to its shareholders. That commitment and shareholder-centric culture will last well beyond Buffett. Even though Berkshire doesn't pay a dividend, this is one stock that every income investor should own.