7 out of the last 15 years, and 4 out of the last 5, have seen Berkshire Hathaway's (BRK.A, BRK.B) increase in per-share book value fall below that of the S&P 500's return, with dividends included. This is Buffett's own preferred method of evaluating management's performance, even though per-share book value operates as a significantly understated proxy for intrinsic value. To paraphrase past statements by Buffett, what's the point in owning Berkshire shares if they fail to beat the S&P 500? You might as well just by an index fund.
Because of this, shareholders have begun to get antsy. A recent shareholder proposal read:
Whereas the corporation has more money than it needs and since the owners unlike Warren are not multi-billionaires, the board shall consider paying a meaningful annual dividend on the shares.
Warren Buffett has articulated Berkshire's dividend policy in his shareholder letters, and explained why he is against Berkshire paying them out. His order for allocating available capital is as follows:
- Reinvesting in currently existing businesses already in the Berkshire family. Product lines should be both extended and improved upon. Steps should be taken to widen the economic moat as much as possible. In 2013, $3.1 billion was spent on bolt-on acquisitions with Berkshire's subsidiaries, ranging in price from $1.9 million to $1.1 billion. $3.5 billion was also spent to acquire additional shares in Marmon and Iscar, businesses already controlled by Berkshire.
- Acquisitions which are unrelated to current Berkshire businesses. Buffett has been honest in voicing his disappointment in being unable to find more "elephants," such as Burlington Northern Santa Fe. Still, $18 billion was spent in 2013 to purchase all of NV Energy and a major interest in Heinz.
- Share buybacks. When Berkshire stock is trading at or below 120% of book value per-share, Berkshire will buy back its own stock. Moving below that level has proved to be rare so far. A sizeable $1.2 billion purchase from a long-time shareholder was made in late 2012. Current price to book value per-share is around 1.37.
- Dividends. Berkshire has not paid a cash dividend since 1967. If Warren Buffett has his way, they most likely never will.
What's interesting is famed investor Benjamin Graham, who also happens to be greatly admired by Buffett, had some strong warnings about these sentiments. Buffett calls Graham's The Intelligent Investor, "By far the best book on investing ever written." Buffett has even written the preface and appendix of newer editions. Yet inside of that very book, Graham wrote:
Efficient finance requires that the stockholders' money be working in forms most suitable to their interest. This is a question in which management, as such, has little interest. Actually, it almost always wants as much capital from the owners as it can possibly get, in order to minimize its own financial problems. Thus the typical management will operate with more capital than necessary, if the stockholders permit it-which they often do.
Graham further presents counterpoints to companies desiring to retain all their profits:
- The profits "belong" to the shareholders.
- Many shareholders need their dividend income to live on.
- Dividends are "real money." Retained earnings have a possibility of not showing up as the promised tangible benefit for shareholders later on.
Graham is obviously correct on the first point. In regards to Graham's second point, Buffett offered a counter to investors who need dividends to live on, in the 2012 shareholder letter. Instead of receiving dividends, simply sell shares each year. This "sell-off policy" was defended by Buffett for 2 major reasons. Dividends offer a fixed cash-out range, which does not leave the investor with a choice. Different investors may want different payout levels. Dividends are also not tax-advantageous, as dividends received are taxed as income.
Dividends certainly are not advantageous for investors when dealing with taxes. The sell-off policy has some other holes in it, though. If the market is in a particularly tumultuous period, with prices wildly pessimistic, a shareholder is losing value by selling shares during this. With dividends, the payout remains consistent, and predictable. Buffett portrayed this as a negative. An obvious counter is that a bigger negative is putting people into a position where they are forced to sell shares for much less than they are worth, in order to generate income. Selling shares at a variable expense vs. the fixed nature of dividends is not necessarily an advantage.
On that third point, Graham himself does allow for the option of retaining a significant amount of earnings, but only under the very specific condition that there was a demonstrative benefit to shareholders.
It is our belief that shareholders should demand of their managements either a normal payout of earnings-on the order, say, of two-thirds, or else a clear-cut demonstration that reinvested profits have produced a satisfactory increase in per-share earnings. Such a demonstration could ordinarily be made in the case of a recognized growth company. But in many other cases a low payout is clearly the cause of an average market price that is below fair value, and here the shareholders have every right to inquire and probably to complain.
I think Warren Buffett has unambiguously proven over the last half-century that he is a capable manager. Since 1964 Berkshire has achieved a 19.7% compound annual gain in its book value per-share. A gargantuan 693,518% overall gain. While the stock is underperforming the market recently, it is important to keep in mind the environment in which this is done. Berkshire typically underperforms during strong market rallies, yet outperforms during slower growth, stagnation, and bear markets. Recent years have seen gargantuan gains for stocks, which are very unlikely to be duplicated in the next few years. Berkshire should return to relative outperformance, even if it is tempered by the magnitude of its size.
Of definite concern though, are companies other than Berkshire with managers other than Buffett. Piggybacking off of and appealing to Buffett's position, they don't have the track record of Buffett. In fact, history shows that the expected future earnings growth is fastest when current payout ratios are high and slowest when they are low. Companies substantially reinvesting retained earnings do not fuel faster future earnings growth overall.
In addition, from 1931 to 2010, dividends accounted for 40% of the return for large-cap stocks in the United States, and 135% of the return from 2001 to 2010, when stock prices stagnated. Dividend yields are far below their historic mean of near 4.5% for the S&P 500, but above their all-time lows set around the turn of the century. In 1999, only 3.7% of companies that first sold their stock to the public that year paid a dividend, down from 72.1% of all IPOs in the 1960's. After a decade of miniscule dividends being the only return investors of an S&P 500 index fund received, it should come as no surprise calls for increased dividends are rising.
Dividend Yield of S&P 500:
That is an aside for Berkshire shareholders when dealing with Berskhire stock, but it is a definite concern for many of their other holdings. Berkshire itself certainly relishes the dividends it receives from its equity holdings. Of the $259 million (5.8%) increase 2013 saw in investment income, the vast majority was from increased dividends earned on equity investments.
With over $48 billion in cash, well above the $20 billion threshold Buffett seeks to maintain, Berkshire is indeed awash in cash. Few companies have had cash piles like this, and when they have, dividends soon followed. By the end of 2002, Microsoft (NASDAQ:MSFT) had $43.4 billion in cash, and it simply could not find uses for it. Less-than-ideal projects and investments would have to be engaged in. Early in 2003 the company declared it would begin issuing a regular quarterly dividend. Apple (NASDAQ:AAPL) cleared $100 billion in cash, but they too started dividend payouts beginning in late 2012.
For as long as Buffett is in control, I strongly doubt a dividend is on the horizon with Berkshire. The board will recommend against any shareholder proposal for dividends, and most shareholders will align themselves with their wishes. However, if the market cools, as expected, and Berkshire continues its trend of relative sub-par book value growth, shareholders might become much more vocal. Buffett has been honest that finding places to put Berkshire cash has been much harder to find, although at present time he is still finding sufficient spots.
Disclosure: I am long BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.