Why Some Companies Never Pay Dividends?

January 22, 2021

“Should I invest in a growth fund that pays no dividends or in a high dividend-yielding fund?”

This is a question that I often get asked. Perhaps the answer can be found in Warren Buffett’s 2012 annual letter addressing the stakeholders of Berkshire Hathaway, the multinational conglomerate holding company he has led since 1965.

Over years of observation, one can see that Buffett has invested a considerable amount of Berkshire Hathaway’s capital in established dividend-paying stocks, particularly in those that consistently increase their payments every year¹like Coca-Cola and Apple. Judging from these figures from the company’s top five holdings in his 2018 annual letter², this strategy seems to be paying off:

Data source: Berkshire Hathaway 2018 shareholder letter

Despite Buffett’s love of receiving dividends, Berkshire Hathaway has never paid out one to its shareholders. This may seem a rather contradictory practice to what he preaches but as Buffett himself puts in his 2012 annual letter³,

The art of “waiting” is indeed one more challenging than it seems. A truly disciplined investor looks beyond short-term concerns and focuses on market growth potential in the long run.

“A number of Berkshire shareholders – including some of my good friends – would like Berkshire to pay a cash dividend. It puzzles them that we relish the dividends we receive from most of the stocks that Berkshire owns, but pay out nothing ourselves.”

However strange it may seem, Buffett’s logic can be explained simply and sensibly in these three aspects he uses the money for; namely Reinvesting, New Acquisitions and Repurchasing.

First and foremost, he firmly believes that the capital is better off being reinvested within the companies they control; with the purposes of enhancing efficiency, expanding reach, creating new products and services, as well as improving existing ones. With the additional cash after deploying money to above-mentioned uses, his next step is to search for new acquisitions unrelated to the company’s current businesses and are “likely to leave our shareholders wealthier on a per-share basis than they were prior to the acquisition.” The third use of the funds is to repurchase its own shares, but only if they are trading at a “meaningful discount to conservatively calculated intrinsic value.”

Further in this letter, he demonstrates how the math works in favour of the sell-off approach which he defines as to

“leave all earnings in the company and each sell 3.2% of our shares annually.”

Dividends impose a specific cash-out policy upon all shareholders.

On the other hand, the sell-off option allows each shareholder to choose between cash and capital. For example, a shareholder can elect to cash out 60% of annual earnings while others go for 20% or nothing at all. In another scenario, the shareholder could also use dividends to purchase more shares; but in doing so, would incur taxes and also have to pay a 25% premium to reinvest (keeping in mind this mantra that open-market purchases of the stock should take place at 125% of book value).

The second disadvantage of sticking to the dividend approach is the tax consequences. Under the dividend programme, all cash received will be taxed whereas the sell-off programme results in tax on capital gains only.

In the same 2012 letter, Buffett proceeds to use his own case to illustrate how a shareholder’s regular disposals of shares can result in increased business investment. “For the last seven years, I have annually given away about 4.25% of my Berkshire shares. Through this process, my original position of 712,497,000 B-equivalent shares (split-adjusted) has decreased to 528,525,623 shares. Clearly my ownership percentage of the company has significantly decreased.

Yet my investment in the business has actually increased: The book value of my current interest in Berkshire considerably exceeds the book value attributable to my holdings of seven years ago. (The actual figures are $28.2 billion for 2005 and $40.2 billion for 2012.) In other words, I now have far more money working for me at Berkshire even though my ownership of the company has materially decreased.”

This being said, a high dividend yield may not always be the best thing as this implies that the company is returning a hefty portion of its profits to investors; rather than reinvesting in growth opportunities. The key is to invest in companies that not only have the capacity to make the payments, but also the potential to grow their dividends and keep doing so in the future. More importantly, you should determine your dividend schedule to cater for your individual needs.