Warren Buffett’s Mentor Tells Him to Pay Dividends

Whenever I politely suggest that Berkshire Hathaway (NYSE: BRK.b) pay a dividend, I’m always politely dismissed.
The objections are predictable: Berkshire Hathaway has no need to pay a dividend. It is, after all, controlled and commanded by Warren Buffett, the greatest investor of the past 50 years. Berkshire Hathaway has crushed its benchmark, the S&P 500, during Buffett’s tenure.
I’ll concede that the past includes a few stunning outliers. Berkshire Hathaway beat the S&P 500 by 105% in 1976. It nearly did the same in 1978, beating the S&P 500 by 84%. Berkshire Hathaway has outperformed its benchmark 34 of the past 50 years.
Berkshire Hathaway is a special company run by a special investor, investors reason. Therefore, it’s best to just keep on keeping on.
But is it? Perhaps changing course is best.
The S&P 500 has outperformed Berkshire Hathaway over the past five years. The S&P 500 has advanced 65% since July 2013. Berkshire Hathaway has advanced 59%. (The comparison considers price appreciation alone. S&P 500 dividends are excluded.)
I’ve long argued that Berkshire Hathaway’s no-dividend policy subtracts from its return potential. I turn to Warren Buffett’s mentor – Ben Graham – to buttress my supposition.
Graham produced an enlightening lecture series in 1946. One lecture centered on an exceptional company run by exceptional management. The company was New Amsterdam Casualty.
New Amsterdam’s policy was to retain earnings. Its dividend was stingy compared to its competitors. Graham specifically contrasted New Amsterdam’s dividend policy with U.S. Fidelity & Guaranty, a competitor and a reasonable benchmark.
The two companies pursued nearly identical business lines. The companies were nearly equal in size. They were nearly equal in assets held. Annual earnings between the two were nearly identical.
The dividend policies, though, differed notably. New Amsterdam paid $1-per-share in annual dividends. U.S. Fidelity & Guaranty paid $2.
Their respective share prices also differed notably. U.S. Fidelity & Guaranty shares were priced around $45 in 1946. New Amsterdam shares were priced around $26. U.S. Fidelity & Guaranty shares commanded a 73% premium. Graham attributed the valuation differences to dividend-policy differences.
Still, Berkshire Hathaway is different. It’s a special business. I disagree, but let’s say that it is. Graham offers a rejoinder: “Since every business is a special business, it seems to me that the argument more or less answers itself. You would have to conclude that there would be no principles by which the stockholders can determine suitable treatment for themselves, if it is to be assumed that each business is so different from every other that no general principles can be applied to it.”
Graham noted that most businesses that eschew dividends consider themselves special businesses. “You would have to conclude that there would be no principles by which the stockholders can determine suitable treatment for themselves,” says Graham, “if it is to be assumed that each business is so different from every other that no general principles can be applied to it.”
Berkshire Hathaway’s financial performance no longer supports its no-dividend policy. It barely matches its benchmark year to year. It lags its benchmark when dividends are included in the calculation.
Would Ben Graham recommend Berkshire Hathaway pay a dividend? I believe he would.
If Berkshire Hathaway were to implement an annual dividend, its shareholders would receive an improved return on their investment. They would also likely enjoy a higher market price for their shares.
Shareholders could enjoy a much higher market price if Berkshire Hathaway were to evolve into a superior dividend grower. Few investors would argue that Berkshire Hathaway lacks the potential to evolve into superior dividend-growth company.