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A dividend from Berkshire? Buffett is considering it

Warren Buffett buys 9.8 million shares of App... 04:54

One thing Warren Buffett has always been emphatic about is the issue of dividends. The legendary investor has often asserted publicly that he doesn't want Berkshire Hathaway (BRK.A, BRK.B), the giant conglomerate he controls, to make such payouts. He believes the company can make better use of its cash pile by reinvesting it to enhance further growth.

But at Berkshire's latest annual shareholder meeting in Omaha on May 6, Buffett reconsidered the hot topic and mentioned, possibly, paying a dividend "reasonably soon."

The matter of dividends, a much-discussed subject among shareholders, is becoming more germane because Berkshire's cash stockpile is approaching $100 billion. Its free-cash generation of $20 billion annually adds to the not-unhappy burden of how to deploy or invest all that capital.

So Buffett decided to address the issue at the meeting. "When the time comes, and it could come reasonably soon, even when while I'm around, and at the time (don't think we can allocate the capital into things we like) that we make a decision, it might include both, but it could be repurchases, it could be dividends." He then noted that he would have a tough time telling shareholders in a few years that it made sense to hold $150 billion of cash.

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Buffett also said that assuming interest rates could normalize, Berkshire could deliver returns at a compound annual rate of 10 percent, after achieving 19 percent annual returns in book value appreciation from 1965 to 2016.

"We think a dividend is the last thing Warren wants to do as he still wants to bag some [corporate] elephants and believes he can afford to be patient," said Edwin Walczak, managing director and chief of U.S. Investments at Swiss-based investment bank Vontobel, a long-time big investor in Berkshire.

"Although stock prices may be rich right now, Buffett expects there would be a dislocation one of these days, and he could then pounce [on a buyout target] just as he did during the financial crisis," added Walczak. "I don't think he has given up looking yet." 

But Buffett is also "very rational," asserted Walczak, and if "he really were sure it would be unlikely he would find a way to invest the cash in a way that would increase Berkshire's intrinsic value, then he would start giving money back to shareholders by way of dividends."

That's exactly what the hordes of Berkshire shareholders are hoping Buffett will do, finally. And the fact that Berkshire's swelling cash hoard is fast approaching $100 billion may just be the clincher that would encourage Buffett to do so. That hoard is likely to continue growing with the company's continued expansion.

Berkshire, an insurance-based conglomerate, has major investments in railroads, energy, financial services, publishing, retailing and manufacturing. Its vast portfolio includes more than $132 billion in marketable equity securities. They include major stakes in Apple (AAPL), Coca-Cola (KO), Bank of America (BAC), IBM (IBM), American Express (AXP) and Wells Fargo (WFC).

Macrae Sykes, equity analyst at investment firm Gabelli & Co., noted that since taking over Berkshire in 1965, Buffett has generated a cumulative book value return of 884,319 percent versus the 12,717 percent for the S&P 500 (including dividends). Sykes added that Berkshire's performance is based on aftertax numbers, while the S&P 500 return is pretax.   

Stocks soar 02:21

Should Buffett decide to pull the trigger on dividends, the stock should quickly accelerate its advance because many Wall Street analysts are likely to push up their ratings and price targets. Dividends are a major attraction to investors because dividend-paying companies have seen their stock prices climb, if not actually soar. 

And as competition intensifies, dividends could lessen any skeptics' arguments against buying shares of Berkshire. Sykes pointed out that "while the moat on the large conglomerate continues to be an area of proud promotion, competitive threats to the company's businesses are more relevant than ever."

And the huge question of who will assume the post of CEO once the 86-year-old Buffett steps down has weighed on Berkshire's shares. Vice Chairman Charles Munger is 93. But Berkshire's stock has continued to steadily rise and outperform the market. Its class B stock is currently trading around $175 a share, not far from its 52-week high of $179.99. Berkshire's class A stock currently trades at about $263,000 a share.

Sykes of Gabelli argues that the significant cash balance, once considered a "sleep aid, has come under more scrutiny, opening the door for a potential dividend policy." And lower interest rates, declining market volatility and higher than "fair" valuations have also diminished the current opportunities for large acquisitions, Sykes believes.

Brian Meredith, equity analyst at UBS, who rates Berkshire a "buy," predicted in a recent report that the stock should continue to outperform the market. Consensus estimates, he noted, are for 5 percent earnings growth for the S&P 500 versus his estimate of 8 percent for Berkshire. "Earnings will benefit from a recovery at [railroad] BNSF as supported by higher coal burn, estimated from the UBS Estimate Lab," he said.

And manufacturing operations rates should gain from any uptick in economic growth, he said, while the market for aerospace components remains robust, supporting results at Berkshire's Precision Castparts unit. 

And even though Meredith is cautious on property and casualty insurance overall, the outlook for GEICO is favorable because it's gaining market share and should see, he believes, margin improvement as loss trend moderates. Meredith rates Berkshire's Class A stock a "buy."

One major equity analyst who rates Berkshire a "hold," Cathy Seifert of CFRA Research, raised her price target for Berkshire's class B  stock on Aug. 4, by $10 a share, to $185. That's 26.9 times her 2017 operating earnings estimate of $6.89 a share (cut by 95 cents) and 22.8 times her 2018 earnings forecast of $8.10 a share (cut by 65 cents).

She raised her price target even as Berkshire missed her second-quarter earnings target of $2.10 a share. It posted earnings of $1.67, down from a year ago's $1.87 a share. "Lacking a cash dividend, we view the shares as fairly valued," she said. Hence, her current recommendation of "hold" on the stock.

Of course, that could change if Buffett decides to reverse his long-held aversion to paying dividends.

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