What Happens When Berkshire Hathaway Pays A Dividend A Decade From Now?

| About: Berkshire Hathaway (BRK.B)


The benefit of buying a company like Berkshire Hathaway years before a dividend payout arrives is that you can build a nice capital gain and simultaneously avoid tax interference.

Buffett and Munger have dropped hints over the years that Berkshire Hathaway will eventually pay a dividend, although neither man has explicitly come out to say it.

The best investors to benefit from buying Berkshire today are those that are buying shares within a taxable account and possess a 10+ year time horizon.

Today, I'd like to talk about a topic I've never addressed in any of my articles: investing in companies that do not currently pay dividends, but have a high probability of doing so over the medium term (defined as the coming five to fifteen years).

The reason why you don't hear it get talked about all that often is because: (1) there is an inherent element of speculation, even if it is intelligent speculation, that comes with the territory of assuming a dividend payout from a company that is not presently doing so, and (2) it takes a somewhat unique investor to have a time horizon in which he or she is able to wait years and years, potentially over a decade, for those mildly speculative conditions to bear fruit.

Given those limitations, why would someone aim to make an investment in a company that may take ten years before the asset starts producing income for shareholders?

Two reasons: (1) You find a company that is internally handling excess cash quite satisfactorily, and (2) you are investing in a non-tax sheltered account where you receive an advantage by delaying the taxation of potential dividend income that you do not yet need (e.g., if you're aiming to live off an income portfolio fifteen years from now, it's okay if the company takes ten years or so before paying a dividend because you don't yet need it).

The classic example of a company presently offering these investment conditions is Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). At present, Berkshire is generating $19.6 billion in annual profits per year, indicating that Berkshire is fast approaching the threshold at which available profits could no longer be fully invested above Berkshire's cost of capital rate. Furthermore, Berkshire's Vice Chairman Charles Munger has speculated at Berkshire's annual meeting that the easiest way to quash mindless empire-building after Buffett is no longer running the company is to institute a dividend policy that commits Berkshire to paying out half of its profits as dividends when the new management regime takes over.

What might that look like if Berkshire pays out a dividend ten years from now, assuming that the company grows at the same rate from 2014 through 2024 that it did from 2004 through 2014 (a reasonable assumption given that the past ten years have marked a good, but not great, decade under Buffett's stewardship)?

You would have Berkshire making $51.41 billion in 2024 profits, and if the company then commits to a 50% payout ratio, it would be returning $25.70 billion in cash dividends to shareholders in the initial year of its dividend commencement. The appeal of planting your Berkshire dividend tree in 2014, rather than waiting for an actual payout to commence, is that such a scenario would allow investors to collect an immediate 8.18% dividend yield-on-cost on their investment at the time of the dividend initiation.

In other words, you'd be collecting $818 in 2024 on every $10,000 invested in 2014, and the reward for your decade of patience that comes with the territory of waiting for a dividend policy to be initiated is that you did not have to sacrifice money in terms of total returns by paying a tax on dividend income before you need it, and you would also be sitting on a nice capital gain that would surely accompany annual profit growth from $19.6 billion to $51.4 billion. For those reasons, an income investor can add a block of Berkshire Hathaway shares to a taxable account and hold them for 10+ years as a nice estate planning tool that allows a company's cash profits to compound internally for a period of time and then eventually convert to annual dividend income at a time closer to when you need to rely on that dividend income to meet living expenses.

This kind of strategy works best for investors that are: (1) investing within a taxable account, (2) content to wait a decade or so for their investment thesis to play out, and (3) have flexibility with their selling plans in case Berkshire does not come around to paying a dividend and they must instead rely on the price quotations for Berkshire at that time to meet their income needs by selling shares.

Over the years, Buffett has dropped subtle hints that a dividend will eventually be in the offing for Berkshire shareholders by noting that Berkshire will not be able to deploy all retained earnings effectively forever. Munger has been more blunt, noting that dividend payouts would put a floor on Berkshire's stock price if immediately instituted after Buffett's death and the restraint that dividends put on capital allocation would institutionalize discipline upon the next managers of Berkshire's operating companies and investment portfolio. If you want to reap large capital gains, and allow your money to compound a bit internally before a dividend payout becomes official, it can be intelligent to buy the Berkshire shares now before the day of the dividend announcement eventually comes.

Disclosure: The author is long BRK.B. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.