Last Updated on July 12, 2021 by Oddmund Groette
Dividend investors only invest in companies that pay regular dividends. We believe you should be agnostic and invest in any company that is likely to be a good investment – no matter if it pays a dividend or not.
Berkshire Hathaway has been a good investment because it doesn’t pay a dividend. In this article, we explain why: because retaining earnings make a higher marginal rate of return for the shareholders.
Managements often mouth that paying a dividend is doing something for shareholders. It is precisely the opposite. Instead they are saying, “Sorry, we can’t do anything with it; see what you can do. Good luck!”
A dividend rewards shareholders?
Dividend investors often claim that dividend rewards shareholders. It’s kind of “money for nothing”.
But most of these investors forget that a dividend is simply a transaction from one pocket to the other where shareholders gain no extra wealth. It’s simply a transaction from the company to the owners.
Dividends do nothing for the shareholder unless it’s reinvested. Charlie Munger is famous for saying he prefers investments where you can “sit on your ass”. When the burden of reinvesting is transferred to the shareholders, it means you have to get off your ass!
Berkshire Hathaway has been a good investment because it doesn’t pay a dividend
Many investors don’t invest in for example Berkshire or Markel because these companies don’t pay a dividend. That is rather odd.
Would Berkshire’s shareholders be wealthier if Berkshire had paid a rising dividend? Berkshire could pay a dividend, but shareholders are of course happy not to receive one. Not receiving a dividend means that your capital is at work!
If Berkshire paid a dividend, shareholders would be a lot worse off because they pay a premium to equity when reinvesting.
Investing is about long-term compounding
Dividends seem to be by far the most preferred method of being “rewarded”. It’s of course pleasant to receive a dividend quarterly, but at the end of the day any investment should boil down to total long-term returns. Whether or not you need cash to pay for living expenses or reinvestment, you need to find the optimal way to make the most off of your capital and withdraw your capital efficiently.
I believe dividends often distract from the real issues: growth and marginal rate of return (reinvestment return).
A dividend policy is often reported but seldom do we see explanations justifying the particular course of action from the board. That’s a shame, because a dividend is just one of five possible allocations for retained earnings, and the focus should be to do this in a value-enhancing way.
Allocations done intelligently could be just as value-enhancing as the underlying operations, as explained very well in William Thorndike’s The Outsiders (which gives eight examples of managers that took advantage of value-enhancing allocations).
Always ask yourself: where is my capital of best use, in my pocket or in the company’s pocket? Because dividend reinvestment (DRIP) almost always means a lower marginal rate of return, you can accept lower returns for retained earnings.