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Why does Warren Buffett not like dividends?

09/22/2021 | 08:49am

Warren Buffet, perhaps the most famous investor, is known for his radical stance on dividend policies. Indeed, Mr.Buffett considers that dividend payments are rarely a wise choice for the development of a company. Although, most of the companies he owns in his portfolio pay a dividend, he is strongly opposed to it. His company, Berkshire Hathaway, has very large cash reserves but does not pay any dividend, Warren Buffet justifying this choice by the fact that he prefers to use this cash in a more efficient way. But why is Mister Buffett so opposed to dividend payments?

With more than 60 subsidiaries in various industries, Berkshire Hathaway must spend a portion of its profits on their ongoing business needs. But once this is done, how does Berkshire Hathaway use its profits? There are several choices, and Warren Buffett ranked them in 2012 in a letter to shareholders.

Option 1 - Reinvesting profits in the company

Above all, Buffett prefers to reinvest Berkshire's profits into the company. The profits of the group's subsidiaries can thus be used to improve their efficiency, expand their scope of action, create new products and services or improve existing ones. Warren Buffett considers that reinvesting in the company brings more long-term value to shareholders than paying them directly (via dividends in particular). The financial success of the company also rewards shareholders as the stock price increases. By reinvesting profits in the company, Warren Buffett benefits from significant long-term internal growth.

The statistics support Buffett's view that using earnings to shore up a company's financial position results in greater shareholder wealth than paying dividends. As shown in the chart to the right, Berkshire Hathaway's BRK-A stock rose +137,556% between 1979 and 2021 compared to +4,254% for the S&P 500 over the same period.

Source: TradingView

Option 2 - Use earnings to make acquisitions

Buffett also uses the capital generated by Berkshire to acquire entire companies. These can be large acquisitions like the $44 billion Burlington Northern and Santa Fe Railway, or smaller acquisitions to add to the group's many subsidiaries. When an opportunity to buy a company for a good price arises, Berkshire Hathaway uses its profits to make the purchase.

Option 3 - Common Stock Purchases

When Berkshire Hathaway can't buy the whole business, the US company simply takes a significant stake in the undervalued company. Berkshire's stock portfolio is valued at over $290 billion. Currently, Berkshire Hathaway has $142 billion in cash and US T-Bonds maturing in 3 months or less. A more than comfortable amount for future acquisitions.

Option 4 - Share buybacks

Companies can choose to return capital to shareholders in two main ways: dividends and share buybacks. Many companies use a combination of the two, but one of the two methods often takes precedence. For example, if Bank of America pays a decent dividend, the company spends a lot more money buying back shares. So, would Warren Buffett prefer to receive a high dividend from all of his shares, or would he prefer that management spend more of the company's capital on stock buybacks? The short answer is "it depends". Buffett's general thinking is that if a company can buy back its own shares at a price below their intrinsic value, buybacks make sense. As Buffett says, "it's hard to go wrong when you're buying bank notes for 80 cents or less". In other words, if you could buy a $100 bill for only $80, wouldn't you want to do so as often as possible?

However, implementing a Buy-Back policy simply to reduce the number of shares and artificially increase the net earnings per share is a bad idea. A share buyback should only take place when there is a strong undervaluation.

In short, if a company is trading at a significant discount to its intrinsic value, Buffett is all for management allocating large amounts of capital to buybacks. On the other hand, if a solid value cannot be established, Buffett views buybacks as a poor choice.

Option 5 - Do nothing

If Buffett and his team don't like any of their options, they can choose to let their cash pile up to fund future acquisitions and share buybacks. In fact, that's exactly what's happened in recent years - Berkshire had $21 billion in cash at the end of 2018 and currently has nearly $42 billion.

Option 6 - Pay a dividend

As you'll have gathered, the main reason Warren Buffett doesn't want Berkshire Hathaway to pay a dividend is that he simply doesn't think it's the smartest way to use Berkshire's profits.
In addition, other reasons have been given in the past related to not paying a dividend. First of all, each investor may want different returns, so there is no easy way to decide on a dividend policy. Dividends are also taxable to shareholders where an unrealized gain is not. This means that a long-term investor, as long as he has not sold his shares, isn't taxed.


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