Warren Buffett lays down logic against dividends

In his latest annual letter to shareholders, Buffett explains why paying dividends doesn't make sense.

The annual letter that Warren Buffett writes to his shareholders is something of an event in the business world. What is normally mundane business communication from other CEOs, has become an art form in Buffett's case. This year's letter has excited media people more than most because it has a long discussion about the media business. Over the last few years, Buffett has bought a string of newspapers even though the newspaper is widely understood to be in severe decline in the US.

However, the most interesting part of the letter is Buffett's response to the constant clamour for dividends that he hears, given his holding company Berkshire Hathway's $50 billion cash chest. He lays down four uses to which a company can put its cash, in decreasing priority.

First, it should reinvest the money in growing its core business. If that cannot be done productively, then it should use the cash to acquire or expand into other businesses. If that too is not feasible, then it should repurchase its own shares if they are available cheaply enough. He lays down 120% of book value as the standard for cheap enough that Berkshire follows. He terms share buybacks at this level as 'buying a dollar for 80 cents'. Only if this too is not possible should a company consider paying dividends.

It's an interesting view, and one which is hard to fault. The logic of prioritising share buybacks over dividends is sound, even though it won't sound so to Indian ears. But what about investors who want a cash income from shares? Buffett's recipe is interesting - sell some stock to realise the amount you want. He says that this always leads to a better outcome for the business and the shareholder, including in tax-efficiency.

The letter is a great read, but don't take my word for it - download it and read it for yourself.

 

also read

Cyberdude

Blogosphere expand and expanding

blog comments powered by Disqus