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By Josh Peters, CFA | 04-29-2015 02:00 PM

What Dividend Investors Can Learn From Warren Buffett

Buffett may have paid a premium for some of his recent purchases, but these defensive, high-quality names can generate cash flow growth for decades to come, says Morningstar's Josh Peters.

Note: This video is part of Morningstar's coverage of the 2015 Berkshire Hathaway Annual Meeting.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here with Josh Peters; he is the editor of Morningstar DividendInvestor newsletter and also our director of equity-income strategy.

He says you shouldn't expect a dividend from Berkshire Hathaway (BRK.A/BRK.B) anytime soon, but that doesn't mean that dividend investors can't learn something from Warren Buffett.

Josh, thanks for joining me today.

Josh Peters: Good to be here, Jeremy.

Glaser: Before we get into what Buffett is buying for Berkshire, let's take a look at Berkshire itself. Famously, they don't pay a dividend; Buffett has been very resistant to paying a dividend, though they are sitting on a ton of cash. Do you think that this is a prudent move for the company?

Peters: Well, first of all, I take Mr. Buffett at his word. I don't think he wants to pay a dividend, and I wouldn't buy the stock at any point in anticipation of the company paying one.

A couple of years ago, he actually devoted a chunk of one of his annual letters to talking about dividend policy and suggesting that shareholders, if they wanted income or something that would function like income, they could just sell off a few shares in order to achieve that end, some cash flow for their portfolio.

Now, the way I view Berkshire Hathaway is very different from how I would view almost any other company with any other operating business. I might like the business; I might like the management. I might trust them as capital allocators, but I still don't want all of the cash flow produced by the business bottled up in that entity because, for example, General Mills (GIS), they generate a lot of free cash flow, but it's important for them to pay that as a dividend. If they were trying to reinvest all that internally in the business, then they would have the capacity to produce way too many Cheerios--way more than they can actually sell. Or they would go on an acquisition spree into all sorts of other businesses that they probably wouldn't know how to run.

So, I have tremendous respect for General Mills; it's one of my top holdings. I love the company, but I want them to stick to their knitting, and that's the packaged-food business.

Berkshire is a very rare creature where it's been able to thrive as a collection of very disparate businesses because it has the world's best capital allocator at the top. So, there, the formula is different. If you are thinking about Berkshire paying a dividend, then you have to compare that with what Buffett could do if the money was retained internally. And even now that Berkshire is huge, there is still a better-than-average chance that Buffett can do better with that capital than the average shareholder stands to in, say, an index fund or something like that. That's essentially what I would think of as the hurdle rate.

I wrote about this a couple years ago. I said, "In Buffett We Trust, All Others Pay Cash." I think that's how you want to view that.

But there are other ways to learn from Buffett's approach to capital allocation, as opposed to trying to buy Berkshire for a dividend, and that is to look at the kinds of companies that he actually owns and what those companies do within the Berkshire shell.

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