Monday, July 24, 2006

Blog of the Week: Berkshire Ruminations

A few thoughts on dividend policy

Famously, Berkshire Hathaway has never paid a dividend. In theory, dividends represent a way to distribute money to the owners of a business should the business have no better use for that money. A textbook might say that in the absence of any “positive NPV projects” a company is better off paying a large dividend. Again, the analogy to the small business owner is one that I think best illustrates the theory behind a dividend policy.

Imagine you are a sole proprietor and, as such, have a right to all the income your business earns. You would then have two options as to what to do with this newly acquired cash. You could reinvest the income in the business (retain earnings) or you could pay yourself, the individual, a large dividend. Which would you prefer?

Your preference ought to be determined by where you could best deploy that excess cash. If you as an individual see a great investment opportunity outside your business – say for instance shares of WAG selling at a huge discount - you might want to pay yourself a dividend to take advantage. But you should only do this if your business looks to be an inferior investment. That is, it would make no sense for you to pay yourself a dividend and buy WAG if your business is growing wildly, say for instance at a 40% annual rate and you could expand it should the business retain those earnings.

Such is the justification for Berkshire’s no-dividend policy. Mr. Buffett has always felt...

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