Retaining earnings and reinvesting them at a high rate of return, even if it's not as high as it had been for Berkshire historically, is still the value-maximizing situation for this one particular company.
When I say "the exception that proves the rule," you have very, very few companies that are able to allocate capital as widely, across a variety of different industries, business activities and whatnot, or as wisely as Warren Buffett can.
In Berkshire Hathaway, you're really getting a big mutual fund, essentially, of some of the world's best businesses, including insurance, which he's done very well by. Which, in turn, explains why the company holds a lot of cash--to have ready for insurance claims.
In running these portfolio of businesses, he's essentially acting more like a portfolio manager than, say, the CEO of any other company on the street.
Glaser: So that's why you'd say a company like Apple, who also has a ton of cash, maybe should be paying a dividend, because they have less opportunities to invest so widely?
Peters: Actually, that's a perfect comparison, because Apple is a company I think should be paying a fairly large dividend. They should be returning most of their free cash flow to shareholders. Because if you look at Apple, compared to Berkshire Hathaway, both very profitable, but Apple has established itself a set of things that it's very good at doing, but it's very narrow; so within personal computers, personal electronics, the iPhone.
They're very, very good at what they do, but there's no reason to think that Apple could take some of its shareholders' cash, some of the earnings of the company, go off and invest in insurance, or invest in the Burlington Northern railroad, or a carpet manufacturer, or a chain of candy shops, and be able to do anywhere near as well as they could either in their existing operations, or as well as somebody like Warren Buffett is doing.
The lesson, I think, with Berkshire Hathaway actually proves most companies should stay within a relatively small circle of operations that they're good at, that they have competitive advantages, know how to run, accept the kind of growth potential that those businesses can have, and all the rest of the cash that the business generates should be returned to shareholders.
Glaser: So do you think that Warren Buffet is then philosophically opposed to dividends?
Peters: No, I don't even have to guess at that. Here's the way I would think about it. It was over 30 years ago now that Berkshire Hathaway acquired See's Candies, and he has pointed out that this business has been a phenomenal long-term investment and has produced a lot of cash flow.
Well, where did that cash go? It's not piling up in a checking account somewhere in California. Every year, Warren Buffett and the managers of See's are sitting down, deciding how much of the earnings of See's should be retained in the business and reinvested, to open new stores or for other capital projects.
The rest is being paid, quite literally, as a dividend, up to the holding-company level, where Buffett can then decide where best to invest that. It doesn't necessarily need to go back into See's Candies. The company could never have grown anywhere near as fast as all the cash it could have generated would have allowed it to grow.
So there's that theoretical disconnect, and a lot of companies out there don't recognize that, and a lot of investors don't recognize that. There's all kinds of dividends going on inside of Berkshire Hathaway.
Glaser: So that could be an interesting lesson for investors, when they're getting dividends from companies, to think about how they're going to reallocate that money.
Peters: You might even think about it very similar to Warren's own stake in Berkshire Hathaway. He is not receiving a dividend from his own shares, because he doesn't need the income. You might not need dividends from your own personal portfolio right now, or cash flow to be taken out. You don't need it for living expenses. But you have the opportunity to reinvest your dividends internally, inside of your portfolio.
When you own a portfolio of companies that pay dividends, you're getting the steady cash coming in. You get to take on some of the capital-allocation opportunities, just like Warren Buffett does at the top of Berkshire Hathaway.
If you own a portfolio of stocks that don't pay any dividends, then it's all the corporate managers of the businesses that you own that are making all of those decisions. I think most investors would like to call some of those shots on their own. So, yet another reason to want to put together a portfolio of good dividend-paying stocks.
Glaser: At what point, if ever, do you think Warren Buffett will decide to pay a dividend?
Peters: That's a question that's really impossible to answer. Like I said earlier, I think that he's probably the best person to make that call. I would think that with his talents, his knowledge of the markets, his psychological and mental capacities for investing that really set him head-and-shoulders above any other investor alive in the world today, that there's really no reason to expect Berkshire to pay a dividend while he is still running the company.
I think, at some point, if he's retired, no longer in charge of Berkshire Hathaway, which could still be a long time from now, then Berkshire's board will have a much more difficult decision, which is, do you want to trust some other manager with the same kind of responsibility of reinvesting all of the earnings?
At that point, that might start to be the time that the board would want to look at distributing some of the company's excess earnings.
Glaser: Josh, thanks so much for joining me today.
Peters: Happy to be here.
Glaser: For Morningstar.com, I'm Jeremy Glaser.
