A company can do any of these things with its profits - Pay dividends; reinvest the profits; acquire other companies; buy back shares or hoard cash. Most of the companies generally opt for options 1 and 2. But Mr Buffet's company, Berkshire Hathaway, has never paid dividends to its shareholders. Though, he is the propagator of the companies paying high dividends. So what is the reason for doing so? An article in financial times highlights this point and tries to give the reason for it.
The trend in US and UK last year was for companies to hoard cash. They even brought the head count down in order to control costs. But the Oracle of Omaha decided to be a contrarian in this aspect as well. In 2012, his company Berkshire increased its capital investment by nearly 20% as compared to FY11. The company also increased its employee strength during this time.
As per Warren Buffet, reinvesting the profits in the business rather than paying dividends is an indirect way to increase the investor's wealth. That means focusing towards increasing intrinsic value of the company's stock. He prefers to reinvest in the existing business, or using it to grow through acquisitions. Share buyback is another option that Buffet considers. As per his investment philosophy, if the intrinsic value is higher than the actual stock price of the company, then the stock offers an investment opportunity. In fact greater the discount to the intrinsic value, the more attractive the investment opportunity. Conversely, if the intrinsic value is lower than the current market price, then the stock is 'over valued' and should be avoided.
Let's face it. Buffet's investment principals have made Berkshire as one of the most successful companies. In 2012, Berkshire suffered largest loss due to Hurricane Sandy yet the company could make US $1.6bn on insurance underwriting. If the world continued to follow his advice and go ahead with its investment decisions, the financial crisis would not have been rampant and decisive. Continued earnings growth, meaning full investments and share repurchase at right price have been the key catalysts for the success of Berkshire.
We believe that in his usual style Buffet has given a sound investment lesson to companies and governments across the world. To come out of the crisis, they need to step up on investments. Investments will boost growth and eventually bring them out of the recession. But unfortunately most of the developed world is busy printing money while the emerging world is busy hoarding money. No one is investing.