Should dividend investors buy Berkshire stock?

By: ispeculatornew
Date posted: 11.11.2010 (4:00 am) | Write a Comment  (6 Comments)

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Unless you have lived on another planet, you have heard of Warren Buffett and his infamous company, Berkshire Hathaway. The company that he founded was once ago a tiny blip but after decades of growth, it is now the model that portfolio managers learn about in business school and then often try to replicate once they get their first assets to manage. You would think that it must be science for Buffett to outperform by such a wide margin the S&P500 over so many years. In fact, Buffett is one of the easier managers to “replicate” because his investment theory is quite simple. You can and perhaps have already read books about it but some of the basics are:

-Invest in businesses that you understand
-You must buy a company that has excellent management
-Look at their financial statements, is it a sound business?
-Ignore the market noise
-Avoid unnecessary risks (leverage, etc)
-Buy only at very reasonable prices

Those basic principles have led Buffett to buy businesses or stocks that have provided steady income flows to Berkshire. A good example is the insurance business. Berkshire has been active in the insurance business which provides steady flows of income every year. The company collects premiums and has always been safe in doing business. What do I mean? The insurance business has always been very competitive as companies offer ever lower premiums. Buffett’s theory on this has always been to only offer insurance when you can make money. If that means getting no new clients, then so be it. Over time, that strategy has been successful as companies that were too aggressive in their pricing had to roll back or even get out of the business.

In case you have not heard, just look at this chart of Berkshire’s stock and you will understand how incredible Buffett’s return has been over the years.  A business that has been able to increase its cash flow, get diversification all around the world and across different industries. Berkshire even displayed how prepared it was for bad markets when it barely moved during the recent financial crisis. While other banks, insurance companies and competing companies were struggling, asking the government for help and declaring bankruptcy, Berkshire stood tall, with its strong cash position. Because of that, it was also able to get very good deals by lending money to Goldman Sachs and others as well as buying cheap assets around the world.

There has to be a catch right?

The big catch

The catch of course is that dividend buyers look for solid companies that can grow their business over time in order to PAY dividends. That is the problem. Berkshire, despite its huge cash reserves, does not pay back its investors through dividends. At least, it has not done so in the past. There have been hints that might happen in the future but there is certainly no way to be sure about that. It is a big point of debate among investors as many have been requesting that Berkshire pay a dividend with its excess cash. So far, Warren Buffett has opted otherwise.

Why he keeps the money

There are many theories as to why Berkshire does not pay dividends. The more “official” one is that Warren Buffett believes he can deliver a better return with that money than investors would be able to generate by themselves. So why not let that choice up to them by offering a dividend tat investors can or cannot reinvest? Many possible reasons but here are a few:

-By paying dividends, Berkshire would force investors to pay taxes. If it assumes that all investors (or most of them) would want to reinvest, they might be better off leaving the cash in the company which increases the stock’s value. It will be taxed when the investor sells out of his position (as capital gains) but in the meantime it puts more money at work
Warren does not want to pay taxes of his own: Buffett is by far the largest shareholder and some speculate that he simply does not want to pay taxes himself
Berkshire does need all of that cash: There is no doubt that when things turn bad, having a huge cash pile is key. When opportunities are out there, it’s too late to raise cash. That is the same reason why companies like Microsoft and Apple are stacking huge cash piles
Buffett does not believe in dividends: Some bring up this theory but I don’t think there’s anything behind it. Buffett is exactly the type of investor that goes after steady income flows. That is not the reason why Berkshire is not paying out dividends.

How can Berkshire be a dividend stock if it does not pay dividends?

There is no doubt that someone could easily argue me on this, but follow me for a just few minutes

#1-You build your own passive income dividend portfolio

-You invest money in a brokerage account
-You do a stock selection
-You reinvest dividends into that diversified portfolio
-You add new stocks that complete your portfolio with your account contributions
-You reinvest all proceeds until you are ready to start living off of passive income
-You live off of the dividends from that portfolio

#2-You buy stocks of Berkshire Hathaway (BRK/B)

-You invest money in a brokerage account
-You inherit the diversified portfolio of Berkshire that has steady income and strong management teams
-Berkshire reinvests dividends into the company
-You buy new shares of Berkshire with your account contributions
-Berkshire adds new stocks as it sees fit
-Once you reach a sufficient level, you retire off of your Berkshire shares
-Every few months, you sell a few shares (thus creating your “own” Berkshire dividend while in theory the shares continue to gain value thanks to the steady income flow into Berkshire’s bank account

Thoughts?

I’m not saying that Berkshire should be purchased as a dividend stock or as the sole property in your retirement portfolio. But I am saying it’s worth considering having it included. I know it’s a bit extreme for many of you but thought it would be interesting.

Do you agree?

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6 Comments

  1. Comment by Zavi — November 11, 2010 @ 7:46 am

    I didn’t see it that way. I think this is a bit extreme… but thanks for sharing great schemas.

    It’s still interesting that Berkshire Hathaway is not paying any dividend and that its portfolio is represented by mostly dividend-paying stocks (even with all the hypotheses you gave)!!

    I would not invest in Berkshire Hathaway for my dividend investing strategy, but mostly for my value stock strategy…

    I thought that the advantage of dividend paying stocks is to hold them outside of Registered Plans to benefit from the dividend tax credit… so investing through BRK, you lose the purpose of it?

    Thanks.

  2. Comment by IS — November 12, 2010 @ 4:46 am

    @Zavi – Very good points, I think it really depends on how you’re investing is done.

    @Blue Octopi – Ahh that is pretty bad. Thanks for letting me know, it’s corrected:)

  3. Comment by Blue Octopi — November 12, 2010 @ 1:53 am

    It would probably help your credibility if you could spell Mr. Buffett’s name correctly. It’s BUFFETT, as in “Warren” or “Margaritaville”, not “buffet” as in Golden Corral! 🙂

    All ribbing aside, good post and a good analysis.

  4. Comment by The Passive Income Earner — November 12, 2010 @ 12:06 pm

    It would not be part of a dividend strategy for me either. If I bought it, and I currently don’t have it, it would be because it fits in my portfolio. His value approach to finding companies is what many dividend investors try to replicate.

    At the end of the day, the company itself is so diversified that it almost feel like an ETF or a Mutual Fund but extremely well managed for investors rather than for bonuses by the manager.

  5. Comment by Ryan — November 12, 2010 @ 1:07 pm

    As an income investor always looking for ways to diversify my portfolio, I like the premise of this post. But it has quite a few factual errors. For instance, Buffett didn’t found Berkshire Hathaway – he began buying Berkshire shares in the 60’s and eventually took control of it.

    Seedlings of Berkshire have been around since the 1830’s… surely you don’t think Warren is THAT old 🙂

  6. Comment by IS — November 18, 2010 @ 11:25 am

    @Ryan – Thanks for pointing that out, good point:)

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