Warren Buffett once said that shunning dividends in his early years running Berkshire Hathaway Inc. allowed him to refocus the company on better businesses, much as a person would overcome “a misspent youth.”
The 82-year-old billionaire is now focused on his legacy as he prepares the company he’s overseen for almost five decades for new management. Using his annual letter tomorrow to outline a dividend strategy could help explain to shareholders how the company’s next leaders should approach the challenge of allocating profits.
“It may ease the burden on the successors” if they are able to initiate a dividend, said Richard Cook, co-manager of the Cook & Bynum Fund, which counts Berkshire among its largest holdings. Berkshire and its units “generate a lot of cash.”
Buffett has sought to teach shareholders about business, investing and corporate governance through the annual letters and meetings held in Omaha, Nebraska, where Berkshire is based. As the company grew with investment gains and acquisitions, so did its cash pile, which reached $47.8 billion at the end of September. That’s made the task of allocating the funds more difficult, because it’s hard to find worthwhile, large investments, Buffett has said.
The chairman and chief executive officer began buying back shares in 2011 and devoted part of his letter last year to explaining when repurchases make sense. He told CNBC in May that he would probably discuss what makes a logical dividend policy in this year’s letter.
“It’s a very sensible move” to describe when companies should pay a dividend, so that the next CEO will be seen as having Buffett’s blessing, said Tom Russo, a partner at Gardner Russo & Gardner, who oversees more than $5 billion, including Berkshire shares. After Buffett’s gone, there will be “a tendency to second-guess,” Russo said.
Buffett took over Berkshire in 1965 and transformed it from a maker of textiles and men’s suit linings into a $251 billion company that sells insurance, hauls freight, generates electricity and operates dozens of manufacturing and retail businesses. His track record and opinions have made his letters a must-read on Wall Street.
He said in the 1985 letter that dividends make sense only when managers can’t generate adequate returns by keeping money in the business. Berkshire didn’t pay a dividend because it had been able to earn above-market rates on retained profits, he said at the time.
Returning a significant amount of that money to investors might have been “disastrous,” Buffett wrote, because the three businesses that he and Vice Chairman Charles Munger oversaw when they started had made little money, incurred losses or shrank to a fraction of their original size two decades later.
“It’s been like overcoming a misspent youth,” Buffett said of their effort to expand into the insurance industry, newspaper publishing and chocolate-making. “Clearly, diversification has served us well.”
Buffett has continued to find better ways of investing Berkshire’s extra cash. During the last three decades, he’s amassed the biggest stakes in companies including International Business Machines Corp., Wells Fargo & Co. and Coca-Cola Co. He’s also bought whole companies, including railroad Burlington Northern Santa Fe and reinsurer General Re.
This month, he joined Jorge Paulo Lemann’s 3G Capital in a $23 billion deal to take ketchup maker HJ Heinz Co. private. The transaction will give Berkshire $4.1 billion in equity and $8 billion in preferred stock that pays a 9 percent dividend, according to a regulatory filing.
Buffett uses his letters to call out his own blunders and praise managers at operating units such as reinsurance chief Ajit Jain and Matt Rose, the CEO of BNSF. The billionaire relies on the heads of subsidiaries to oversee day-to-day operations, leaving him and Munger time to allocate the profits.
Berkshire’s size could make a dividend necessary at some point because there may be no better way to invest the funds, Munger said at a 2011 meeting in Pasadena, California.
“I think that some of you will live to see Berkshire pay a dividend, but I hope I don’t,” Munger, then 87, said in response to an audience member’s question. “You’re saying, ‘Do you predict failure?’ And I suppose I do.”
Buffett said in last year’s letter that the board had selected a manager to be the next CEO, without identifying the person. The billionaire has also been ceding more oversight of the company’s $88 billion stock portfolio to investment managers Todd Combs and Ted Weschler.
Berkshire Class A shares gained 0.5 percent to $152,600, a record closing price, at 4:03 p.m. in New York. The company has rallied 29 percent in the last 12 months, fueled by gains at operating units, a stock buyback and an investment in Bank of America Corp. The Standard & Poor’s 500 Index gained 10 percent in the period.
One deterrent to paying a dividend now is that Buffett, as Berkshire’s largest shareholder, would have to do something with the payments, Russo said. While the billionaire has pledged almost all his wealth to charity, he still oversees Berkshire stock worth more than $50 billion.
“Warren doesn’t want the cash,” said Russo. “He doesn’t need it. He doesn’t want the burden of investing it.”
A dividend may make sense once Buffett’s no longer leading the firm and more of his shares pass to the Bill & Melinda Gates Foundation and his children’s philanthropies, said Russo. Those organizations have an obligation to spend money that a dividend could generate, he said.
Cook, the mutual-fund manager, said he’d prefer that Berkshire forgo a dividend and keep the cash for now.
“You’ve got a 50-year track record of being the best capital allocator in the world,” he said of Buffett. “As long as he’s alive, we think we’re generally better off with him” overseeing the money.