Warren Buffett doesn’t want to pay a dividend – geddit? The Sage of Omaha devoted almost three pages of this year’s shareholder letter to an uncharacteristically dry explanation of his dividend policy – a small matter of 2000 words – but it was hard to escape the conclusion that he was protesting too much.
Ironically, in the third paragraph, referring to occasional mistakes made by Berkshire’s managers, he wrote: ‘The usual cause of failure is that they start with the answer they want and then work backwards to find a supporting rationale.’
Swimming in capital
Hmm…
Simple arguments
Buffett’s arguments can in fact be expressed quite simply. While the sharemarket prices Berkshire Hathaway’s dollars at more than a dollar, shareholders will be better off selling portions of their stock than receiving a cash dividend. Better still, everyone can decide how much they want to sell, rather than accept a homogenous cash dividend.
It’s really just a recasting of the old argument that a company shouldn’t distribute dollars that it can itself reinvest at premium rates of return – after all, that ability to reinvest earnings at premium rates is the reason good companies get priced at a premium to their net asset values.
As always his logic seems irrefutable. But the trouble begins when you realise it could apply to most companies on the sharemarket: after all, companies don’t get left to make sub-par returns for long before they’re gobbled up or liquidated.
Hoarding capital
So, according to Buffett’s argument, the economy’s capital allocation decisions would be left to CEOs rather than investors – bear in mind that we can’t all get cash out of our investments by selling stock, because there wouldn’t be enough buyers. Companies that hoard capital are doing just that, however they imagine investors are shuffling shares between them. And of course this kind of empire-building is just what Buffett has criticised so strongly in the past.
By paying dividends, on the other hand, companies give the free market the opportunity to do what it does best, which is to make its own capital allocation decisions.
Of course there’s room for genius capital allocators such as Warren Buffett to root out the companies making high returns and make sure they get the capital they need. In a sense he’s acting as an investor not a CEO, but this only works when the company is relatively small.
Elephant gun
Now he’s got his ‘elephant gun’ out, looking for gigantic deals, the argument is harder to sustain: the market needs people like Buffett to ferret around in the undergrowth, it doesn’t need them to find ‘elephants’ like Heinz.
Looking at it selfishly from a Berkshire Hathaway shareholder’s point of view – and of course they’re entitled to be selfish – with these big, more marginal businesses, one mistake could undo a lot of good work over the years. And even Buffett does occasionally make mistakes. As he himself says in his 2000-word exposition: ‘Because of our present size, making acquisitions that are both meaningful and sensible is now more difficult than it has been during most of our years.’
Rather than focusing on the overall amount of returns, Buffett would be better to read from his own songbook and focus on their quality. He could do that by distributing some of the dough. In fairness he did do this in December by buying back a parcel of shares, but over the years this has been very much the exception rather than the rule.
Above all Buffett is a collector: an amasser of wealth. In the past, though, unlike the cartoon miser on top of a pile of gold, he’s always made sure the capital is kept busy, generating more wealth (for all of us). But the bigger Berkshire gets and the more its wealth is tied to businesses making more marginal returns, the more he looks like that cartoon miser rather than the great engine of wealth generation he has been in the past.