Investing legend Warren Buffett has never hesitated to share his wisdom with his fellow investors. Yet despite the long-term success of Buffett's company, Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), some investors have complained about the way the Oracle of Omaha invests in comparison to how Berkshire treats its own shareholders.

One long-held misunderstanding among many investors is that Buffett has often invested in stocks that pay ample dividends to their shareholders, but Buffett has never opted to have Berkshire pay a dividend. In his latest annual letter to shareholders, the Berkshire CEO explained that his favorite dividend stocks do more than just make regular payouts to investors -- they also make smart investments elsewhere that together add up to the strong returns that the insurance giant has enjoyed over time.

Why dividends matter for Berkshire Hathaway

Berkshire Hathaway gets a huge amount of dividend income from its investment holdings. In 2018, the company received $3.8 billion in dividends, and Buffett said the amount of dividends Berkshire gets in 2019 should be higher than that.

Blue field with sector icons and word "Dividends"

Image source: Getty Images.

In the past, Buffett hasn't hesitated to explain why he likes stocks that pay dividends. With his ability to deploy investment capital to the best possible use, the Berkshire leader can take the cash that the company receives in dividends and choose where to invest it. Reinvesting in the stock that paid the dividend is one option, but Buffett can also move in different directions to choose an investment with better potential returns when such an investment is available.

The other side of the coin

However, it's too much to say that Berkshire invests in companies because of their dividends. In Buffett's view, it's far more important how his top investments use the bulk of the money that they choose to hold onto as retained earnings.

In the latest shareholder letter, Buffett reveals the breakdown of Berkshire's five top holdings between what they pay in dividends and their retained earnings. His chart is reproduced below:

Stock

Berkshire's Stake

Berkshire Share of Dividends

Berkshire Share of Retained Earnings

American Express (NYSE:AXP)

17.9%

$237 million

$997 million

Apple (NASDAQ:AAPL)

5.4%

$745 million

$2.50 billion

Bank of America (NYSE:BAC)

9.5%

$551 million

$2.10 billion

Coca-Cola (NYSE:KO)

9.4%

$624 million

($21 million)

Wells Fargo (NYSE:WFC)

9.8%

$809 million

$1.26 billion

Data source: Berkshire Hathaway 2018 shareholder letter.

All told, the amount Berkshire receives from these five holdings in dividends is $2.97 billion per year. But retained earnings add up to more than twice as much -- $6.84 billion at last count.

Why are retained earnings more valuable than dividends?

Buffett points to two reasons he appreciates the value of retained earnings at his top investments. First, over time, they've produced a large portion of Berkshire's overall returns on investment. All of his companies have generated capital gains that exceeded the value of their reinvested capital.

Even better, Buffett likes that many of the companies take a portion of their retained earnings and use it to buy back shares. By doing so, Berkshire's stake in the underlying company goes up without it having to buy a single share. As an example, Buffett points out that eight years ago, Berkshire's stake in American Express was just 12.6%. But because of the stock buybacks that the card giant has made in the interim, Berkshire's proportional ownership has risen by more than five percentage points.

For an investor who prefers owning big chunks of great companies rather than small positions, repurchases help Buffett achieve his goals. And where there are dividends, there are often buybacks -- especially in the current investing environment.

Check out all our earnings call transcripts.

Don't expect dividends from Berkshire

Buffett also took the opportunity to note that he expects Berkshire's own stock buyback activity to rise in the future. As long as repurchases give shareholders the right to decide whether to incur taxes by selling their stock, it's likely that Berkshire will use that method of returning capital to shareholders rather than paying dividends. That won't necessarily make dividend investors happy, but it is consistent with Buffett's thinking behind why he really likes the stocks that generate enough cash to pay dividends while also maintaining ample retained earnings.