Wed, 1 May 2013
Buffett has limited opportunities to continue allocating capital within Berkshire at large returns, making it more difficult for the firm to not pay a dividend, says Morningstar's Gregg Warren.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. In Warren Buffett's most recent annual letter, he spent quite a bit of time talking about why he doesn't expect Berkshire to be paying a dividend anytime soon. I'm here today with Gregg Warren, one of our Berkshire analysts, to see if this makes sense for the company. Gregg, thanks for joining me.
Gregg Warren: Thanks for having me.
Glaser: So let's take a look about Buffett's discussion first in this letter. Can you walk through some of the examples, the math that he used, to kind of show why he just doesn't see a dividend payment coming anytime soon?
Warren: Well, it's interesting that we're talking about the dividend again this year. It was pretty much a topic of conversation last year, as well. I think the biggest driver of that is the fact that they continue to build a lot of cash on the balance sheet. I think they had like $45 billion at the end of the December quarter. And if you back out what they've spent on Heinz, you're still looking at probably $35 billion to $37 billion left at the end of this quarter. And Buffett's always talked about having $20 billion in cash on hand to backstop the insurance business. So you're still talking about a sizable amount of cash sitting there that's earning nothing.
The question is: Is that the right strategy for Berkshire? Is that the right strategy for the shareholders? We've always expected to hear shareholders get a bit more vocal as time goes on, especially with that amount of cash sitting on the books. We think the fact that Buffett spent three pages out of the 24 pages that were in the annual letter talking through dividends and setting out some examples mathematically as to why it makes more sense for shareholders to just sell shares as opposed to Berkshire paying out a dividend signifies the sort of pressure that is out there for Berkshire to pay a dividend at some point.
The math that is laid out, if you walk through it, it does check out. It's probably not the best argument overall. I mean, the notion is shareholders with a dividend get the cash in hand now. They don't necessarily have to go through the issue of selling off shares or whittling down their stakes. So from that perspective, it's a bit difficult, and we expect there to be questions on this overall at the Berkshire annual meeting.
That said, we've always been of the belief that companies that can pay dividends, that don't have any good, adequate returning projects to put that money into, should be returning it back to shareholders in dividends and share repurchases. In Berkshire's case, they've been pretty much the exception that proves the rule. I think Warren Buffett has shown an exceptional track record of reinvesting those flows and that cash that's available to them in projects that return more than their own cost to capital. So it's a little bit harder. I mean, Buffett is sort of the exception here, but at the same time I think it's going to continue to be a topic.
Glaser: So you mention that he is the exception because he also said he enjoys getting dividends from a lot of the stocks that he owns. Does he believe that he's really going to be able to outperform, for the foreseeable future continue to outperform? Or are there any other special factors that would make sense for Berkshire to hold on to the cash or maybe why some of the portfolio companies that they own should be distributing money?
Warren: I think when you look at how content he was with the companies that pay him dividends, you got to kind of take a step back, too. I mean, when you look at the four top holdings, you've got American Express, Coca-Cola, IBM, and Wells Fargo, they are all dividend-paying stocks. But Warren Buffett is not a dividend investor. He did not buy those stocks for the dividends. He bought into them because he expected them to generate more consistent and growing earnings over time. The fact that they pay dividends is a positive, but he sort of looks at companies the same way.
If a company does not have an adequate use for that capital, they cannot invest it at above-average returns, they might as well return it to shareholders, whether it's through dividends or share repurchases at appropriate prices. It's really to be determined by that management. I mean, he pretty must trusts the management teams of these companies to do the right things with the capital.
As for Buffett himself and Berkshire, he just thinks that he can earn more on that money than the average investor can. So rather than paying out a dividend to shareholders, he can reinvest that capital, and when you look at the fact that recently he was able to invest money in Heinz and get a 9% guaranteed return on preferred shares, there aren't too many people out there right now, too many investors, that can get a guaranteed 9% return. So in some senses, he's right to sort of make that stand right now. I don't think that's always going to be the case for Berkshire, and I think that at some point they will eventually pay a dividend.
Glaser: Well, let's take a look at share repurchases then. That is something that Berkshire at least is open to doing even if they haven't allocated a ton of capital to it yet. One of the things that happened at the end of last year was they expanded their criteria for how much over book value they would spend on shares. What do you think about that expansion? Is this a sign that we could see some more share repurchases this year?
Warren: A lot of that really depends on the share price. I mean, the thing here is, given the amount of cash that continues to build on the balance sheet that we've talked about, the lack of any real good investment opportunities that Berkshire has in front of them, buying back shares is not a bad idea. I mean, when they introduced the plan back in September 2011--the market was in free-fall--they put it out there at 1.1 times book value, and pretty much over the course of the next year they really didn't buy back much stock. There weren't too many opportunities where the stock was trading below that 1.1 times threshold.
The opportunity came to them in late December 2012 to buy back, I think it was a little bit over $1.2 billion worth of stock from an estate of a long-time shareholder. But it required them moving the bar to 1.2 times book. At first we were a little bit concerned about that. It's like, "What's next? Are you going to move it to 1.3?" I mean, how are we supposed to look at this? But the more we thought about it, the more we realized, here's an opportunity to buy back a big chunk of stock, not have it get dumped on the market and pressure the share price, and eliminate some transaction fees overall.
So it wasn't a bad deal for Berkshire to go out there and buy that stock. But where it's trading now, I mean, the shares are nowhere near that 1.2 times book value, which tends to be right around where we have our Consider Buying price anyways. But I think, the other thing to remember here is that Buffett has effectively set a floor on Berkshire stock at 1.2 times book. Investors will assume that he will buy back shares below that value. So there is now a floor under the stock and he has not had to put any capital to work to get that. So I think from that perspective, it's pretty brilliant.
Glaser: So when you look at the overall capital-allocation standpoint, do you have any quarrels with it, or do you think that they are still doing the right thing for shareholders right now?
Warren: I think it's getting harder and harder to make the case for not paying a dividend when you're sitting on as much cash as they're sitting. Getting next to nothing on $15 billion, $16 billion, $17 billion, is a bigger question mark than "Are you allocating the capital properly?" I mean, I think they are doing a really good job with where they are allocating capital. They are putting more money back to work within BNSF. They are putting more money to work within MidAmerican. Any of the subsidiary companies that need money to put to work in good projects are getting it. So there are no problems there at all. The question is, with them pulling in more money than they have opportunities to put it to work, at what point does it really just makes sense to forgo the issue with the dividend and actually start paying one.
Glaser: Gregg, thanks for your thoughts today.
Warren: Thanks for having me.
Glaser: For Morningstar, I'm Jeremy Glaser.