On the hunt for a stock that pays a dividend? Warren Buffett's Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) last paid a dividend in January 1967, and all signs point to that trend continuing in 2015 -- and for years and years to come.
But have you ever wondered why Buffett does not allow Berkshire Hathaway to pay a dividend? Well, it turns out he's more than happy to answer the question himself.
Why Berkshire Hathaway won't pay a dividend
In his 23-page letter to Berkshire Hathaway shareholders in 2012, Buffett dedicated more than 2,000 of the 18,500 words (about two and a half pages) to explaining why Berkshire Hathaway doesn't pay a dividend.
He begins that letter by noting:
A number of Berkshire shareholders -- including some of my good friends -- would like Berkshire to pay a cash dividend. It puzzles them that we relish the dividends we receive from most of the stocks that Berkshire owns, but pay out nothing ourselves.
It's a valid question, especially knowing that of its eight largest investments in publicly traded companies -- worth nearly $85 billion -- Berkshire Hathaway receives an average dividend yield of almost 2.5%:
And those numbers exclude the preferred stock investments of Berkshire Hathaway, worth a total of $18 billion, in Wrigley, Bank of America, Dow, and Heinz, which pay dividends of 5%, 6%, 8.5%, and 9%, respectively.
With all that in mind, it is clear Buffett himself is a fan of dividends. So why won't he pay one himself?
Well, there are four principal ways that managers can deploy the money their businesses earn: through dividends, share buybacks, investments in new businesses, and reinvesting into existing operations. In the eyes of Buffett, when it comes to Berkshire Hathaway, paying a dividend ranks dead last.
The reason for the dismissal of dividends
Those four principal ways comprise what is known as capital allocation. And as brilliantly described in William Thorndike's book The Outsiders, the CEOs who provide the highest returns to their shareholders are those who are the best at allocating capital.
It should come as no surprise that Buffett was one of the eight CEOs chronicled in the book.
You see, over the last half-century, Buffett and his team at Berkshire Hathaway have been steadily deploying its insurance float -- the difference between what it collects in premiums versus what it pays out in claims -- to invest in companies.
Whether that has meant investing in publicly traded companies, or buying other ones outright -- like BNSF, the railroad purchased by Berkshire in 2009, or Van Tuyl Group, the automotive dealership it bought last month -- Buffett has been wildly successful at finding investments that generate incredible returns.
But it's also important to recognize that Berkshire isn't exclusively in the business of buying other businesses. In fact, Buffett has said that investing in other companies must be second to investing in the individual businesses which make up Berkshire Hathaway:
A company's management should first examine reinvestment possibilities offered by its current business -- projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors. I ask the managers of our subsidiaries to unendingly focus on moatwidening opportunities, and they find many that make economic sense.
And Buffett has been true to his word. Bloomberg reported earlier this year that, at the Edison Electric Institute's annual convention in Las Vegas, Buffett said:
We've poured billions and billions and billions of dollars in retained earnings, and several billion of additional equity [into the energy business] ... And we're going to keep doing that as far as the eye can see.
In fact, Berkshire has spent more money through the first half of 2014 on purchases of property, plants, and equipment ($6.1 billion) associated with the indistry than it did in the full year of 2010 ($6 billion).
But it isn't just the energy business that Buffett is investing in. From his 2012 letter:
Because we operate in so many areas of the economy, we enjoy a range of choices far wider than that open to most corporations. In deciding what to do, we can water the flowers and skip over the weeds.
Berkshire Hathaway has become such an expansive and successful business that it affords Buffett himself, and Berkshire's various management teams, an almost endless array of opportunities to deploy the cash it generates to deliver sizable returns to shareholders by growing the book value of its businesses.
As a result, the share price of Berkshire has continued to grow, providing investors with better returns than if they had received dividends. And, it's also important to note, if income is preferred, shareholders are free to sell their stakes if they so desire.
Dividends are undeniably great things. But a quick calculation reveals Berkshire's shareholders "would have been worse off" if they'd received a dividend of, lets say, 2.5% each year, versus allowing Buffett and his team to reinvest those dollars back into the company that has been able to grow the value of its businesses by 19.7% annually since 1965.