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Case 3 Analysis - Berkshire Hathaway: Dividend Policy Paradigm

Case 3 Analysis - Berkshire Hathaway: Dividend Policy Paradigm
Course

Finance & Society (BFX3999)

41 Documents
Students shared 41 documents in this course
Academic year: 2021/2022
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This document has been uploaded by a student, just like you, who decided to remain anonymous.
Monash University

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3

Decision: Paying a dividend would set an unwanted precedent for Berkshire Hathaway and they should maintain the status quo that has been profitable for investors historically, despite BH currently trading at an inflated price in comparison to book value.

1. Introduction:

Berkshire Hathaway (BH) is a prime example of ³value-driven growth ́ Nadar, 2019), endorsing a non-dividend policy whereby management reinvests retained earnings by acquiring existing businesses and buying back shares. In turn, this stimulates growth in the share price providing a capital gain to shareholders. Warren Buffett, chairman of BH, champions the belief that the stock repurchase model is superior to paying a dividend as it provides a greater return and meets the needs of the individual investor through the sell -off option.

2. Decision & Analysis:

A cash dividend is a certain, tangible cash payment which provides investors with assurance. The ³ELUGLQKDQGEHLQJZRUWKPRUHWKDQWZRLQWKHEXVK ́theory implies some investors prefer the certainty of dividend payments (bird in hand) to the possibility of higher future capital gains (two birds in the bush). This is certainly the case in times of economic downturn, as dividend-paying stocks outperform no cash payment companies during bear markets and recessions because of the attractiveness of a definite yield. Investors in dividend- paying companies not only expect consistent dividend payments, but growth on the dividend payment. This mindset is advantageous because it keeps managers in check as they are more selective in spending the retained earnings of the business, choosing only the very best acquisitions to generate the cash to cover these dividend payments (Barclay & Smith 2008).

A disadvantage of paying cash dividends is that it may slow corporate growth. ³Slower-growing companies tend to pay regular dividends ́ .HOO\ , while faster-growing companies, like Berkshire Hathaway (who have grown more than double the S&P index since 1965), tend to reinvest profits to expand their business further. Companies paying a dividend also restricts the investors freedom to decide the yield on their holdings, as the dividend is determined by management. Other alternative options such as homemade dividends or sell-off options provide this liberty. The cash payment of a dividend is taxable income in Australia which may be

4

disadvantageous to investors in a high tax bracket. They would prefer no cash payment, favouring capital growth which can be recognised through the sale of the shares at the time of the LQYHVWRU¶VFKRRVLQJDQGPD\EHDSSOLFDEOHWRDGLVFRXQW

In tax structures where capital gains are taxed more favourably than dividends, a share buyback plan is advantageous, as buybacks are effectively the company reinvesting dividends for investors but in a more tax efficient way - stimulating capital growth through the share price. Additionally, share buybacks are a way of increasing Earnings Per Share (EPS) for investors. The shares that are repurchased by the company are retired, therefore the number of shares is reduced while the FRPSDQ\¶VHDUQLQJVremain constant, creating an increase in EPS. It is especially advantageous if management feels their shares are under-priced. This presents a risk because if firm value is miscalculated this will cause value destruction, however management is better informed about their own firm value than the public.

A disadvantage of buybacks is that although EPS is increasing with constant earnings, this could EHGHHPHGDVDQ³DUWLILFLDOLQFUHDVH ́DVWKHFRPSDQ\LVQRWQHFHVVDULO\ILQDQFLDOO\VWURQJHUGXH to the buyback which may be mask ing some underlying issues. Investors who buy in at this bump will bear the cost when the market corrects for this artificial increase and finds equilibrium again. Furthermore, dissimilar to dividends, most share buyback programs are not as visible, PDNLQJWKHFRPSDQ\¶Vconfidence on prospects and signals on profitability harder to gauge.

Given Berkshire Hathaway has consistently outperformed the S&P 500 (Appendix 1/Exhibit 1), it would be reasonable to suggest they should maintain the current non-dividend policy. Holding more cash and short-term investments than ever before (approximately 16 billion in cash and cash equivalents ± Appendix 2/Exhibit 2), BH needs to consider whether retaining earnings is providing more present value than paying a cash dividend to shareholders. This can be derived through the NPV of investment opportunities at BH. If projects in the near future have a positive NPV and management believes the value of acquisitions will continue to grow the business, BH will retain their cash. When they do not however, they will either buy back shares or pay a cash dividend.

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Case 3 Analysis - Berkshire Hathaway: Dividend Policy Paradigm

Course: Finance & Society (BFX3999)

41 Documents
Students shared 41 documents in this course

University: Monash University

Was this document helpful?
3
Decision: Paying a dividend would set an unwanted precedent for Berkshire Hathaway and
they should maintain the status quo that has been profitable for investors historically, despite
BH currently trading at an inflated price in comparison to book value.
1. Introduction:
Berkshire Hathaway (BH) is a prime example of ³value-driven growth´Nadar, 2019), endorsing
a non-dividend policy whereby management reinvests retained earnings by acquiring existing
businesses and buying back shares. In turn, this stimulates growth in the share price providing a
capital gain to shareholders. Warren Buffett, chairman of BH, champions the belief that the stock
repurchase model is superior to paying a dividend as it provides a greater return and meets the
needs of the individual investor through the sell-off option.
2. Decision & Analysis:
A cash dividend is a certain, tangible cash payment which provides investors with
assurance. The ³ELUGLQKDQGEHLQJZRUWKPRUHWKDQWZRLQWKHEXVK´theory implies some
investors prefer the certainty of dividend payments (bird in hand) to the possibility of higher
future capital gains (two birds in the bush). This is certainly the case in times of economic
downturn, as dividend-paying stocks outperform no cash payment companies during bear
markets and recessions because of the attractiveness of a definite yield. Investors in dividend-
paying companies not only expect consistent dividend payments, but growth on the dividend
payment. This mindset is advantageous because it keeps managers in check as they are more
selective in spending the retained earnings of the business, choosing only the very best
acquisitions to generate the cash to cover these dividend payments (Barclay & Smith 2008).
A disadvantage of paying cash dividends is that it may slow corporate growth. ³Slower-growing
companies tend to pay regular dividends´.HOO\, while faster-growing companies, like
Berkshire Hathaway (who have grown more than double the S&P index since 1965), tend to
reinvest profits to expand their business further. Companies paying a dividend also restricts the
investors freedom to decide the yield on their holdings, as the dividend is determined by
management. Other alternative options such as homemade dividends or sell-off options provide
this liberty. The cash payment of a dividend is taxable income in Australia which may be

Students also viewed

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