A Non-Dividend Paying Stock for Dividend Investors
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Berkshire Hathaway (NYSE: BRK-B) (NYSE: BRK-A) doesn´t pay any dividends, however, that’s no reason at all for dividend investors to stay away from the company. Berkshire´s quality and fundamental strength are second to none, and there are different ways to generate income from your holdings even if the company doesn´t distribute its cash flows.
A dividend investor in disguise
Warren Buffett is not usually considered a dividend investor, but many of Berkshire Hathaway´s biggest holdings are among the favorite names in the dividend investing community. Coca-Cola (NYSE: KO), IBM (NYSE: IBM) and Procter & Gamble (NYSE: PG) to name three noteworthy examples, are included in both Berkshire Hathaway´s portfolio and in many of the most popular dividend funds.
Dividends don`t come out of thin air: you need a solid business with long-term competitive advantages to generate the cash flows for those payments, and that´s precisely the kind of companies Buffett likes to invest in. Think about Coca-Cola for example, it has the most valuable brand in the world according to Interbrand, scale advantages and a gigantic global distribution network which would be almost impossible to replicate by competitors.
This has provided the muscle to pay an uninterrupted dividend since 1928, and Coca-Cola has recently achieved its fiftieth consecutive year of dividend increases. The company will need to adapt to changing consumer habits and the trend towards a healthier lifestyle, so management is focusing on low calorie sodas, waters, juices and sports drinks. But Coke has gone through harder challenges in the past, and the company will most likely continue growing its cash flows and dividends for years to come.
According to Interbrand, IBM is the second most valuable brand in the world behind Coca-Cola, and it´s another big component of Berkshire´s portfolio with a generous capital distribution program. Since 2000, IBM has returned over $150 billion to shareholders in the form of dividends and share repurchases, and the company has raised its dividends in each of the last 18 years.
IBM holds a leadership position in businesses like hardware, software and services, and its size provides the company with scale advantages when it comes to product development and distribution. The company has positioned itself as one of the most trusted and respected providers of IT solutions on the planet, and that´s a considerable competitive edge versus smaller competitors in the always changing and dynamic tech industry.
Procter & Gamble owns a huge portfolio of leading brands, 25 of which generate more than $1 billion in annual global sales. Besides, the company sells everyday necessities, which provides reliability and stability to its cash flows. Procter is working on reigniting growth and increasing profitability lately, management has launched an initiative to reduce $10 billion in expenses and double its presence in emerging markets with new facilities in countries like China, Brazil, Nigeria, and Indonesia.
Procter has paid dividends for 123 years, and it has raised those dividends in the last 57 consecutive years. Its enormously valuable portfolio of brands, global presence and financial strength make Procter & Gamble another popular name among dividend investors, both individuals and professional fund managers.
These are just a few examples to illustrate the point; Berkshire Hathaway is a diversified collection of many of the best businesses in the world, carefully selected by Warren Buffett himself over the decades due to their competitive advantages and fundamental strength. In terms of underlying quality, Berkshire doesn`t leave much to be desired.
Home made dividends
Buffett has been quite clear on the fact that investors shouldn´t expect any dividends from Berkshire anytime soon. Berkshire has far more cash than it needs, yet The Oracle likes to have it available to capitalize on opportunities that may emerge in the future. He is arguably the most successful capital allocator in the world, so investors would have difficulty trying to put that money to better use than Buffett.
Still, some people like, or even need, regular income from their investments. In that case, there would be nothing wrong with selling a small percentage of your holdings when cash is required.
When a company makes money, it can choose to distribute it to shareholders or reinvest it in the business. If that money is paid in dividends, that amount should theoretically be deducted from the stock price, since investors have already received it and it’s no longer incorporated into the stock value. On the other hand, if it retains those cash flows and invests them wisely, they should generate capital gains for shareholders.
When investors make regular sales of shares, they are reducing their capital gains and transforming them into current income. If Berkshire rises 10% in one year, for example, you could sell some stock in order to make a 3% income and retain the other 7% as reinvested capital gain. This is not the same as a typical dividend from Berkshire, capital gains tend to be less reliable than cash distributions, but it offers higher tax efficiency instead.
Another possibility would be using options to produce income on a long position, for example selling covered calls on your Berkshire holdings. In this case investors would be losing some upside potential, but they would still be making income from their holdings without selling any stock.
None of these strategies would be exactly the same as a regular dividend from Berkshire, but the main point is that there are several different ways to generate your own income from a stock which doesn´t distribute dividends.
Fundamental quality is of paramount importance when it comes to dividend investing, and Berkshire Hathaway offers exposure to many of the best businesses on the planet and all the wisdom of Warren Buffett himself. The company doesn´t distribute cash flows, but investors can find alternative ways to generate income from their holdings. Even without dividends, Berkshire deserves some serious consideration from dividend investors.
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Andrés Cardenal owns shares of Berkshire Hathaway and IBM. The Motley Fool recommends Berkshire Hathaway, Coca-Cola, and Procter & Gamble. The Motley Fool owns shares of Berkshire Hathaway and International Business Machines.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!