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No. of Recommendations: 10
"There are all sorts of people. Most of our portfolio is in tax-deferred IRAs (via company 401K savings).
I would prefer a dividend as it is only taxable when I use it.
Different strokes."

Paying a dividend would be completely irrational, unless your alternative investment opportunities can clear the hurdle of outperforming Berkshire to make up for the minimum 25% reduction in value by the dividend being paid. Alternatively, you would have to believe that Berkshire is not worth more than 1x book.

Let's walk through the math (refer to the annual reports where Buffett talks about dividends). Let's say Berkshire earns $100 in a year and will, on average, trade at a P/B multiple of at least 1.25x. By retaining the $100 in earnings, it creates $125 in market value (let's assume you own the entire company, so those are your earnings). Alternatively, the company can distribute the $100 to you in the form of a dividend, so you now have $100 (assuming you pay no tax, but the situation is considerably worse for those of us who would pay tax).

So, the crux of the issue boils down to the following questions:

1. At what rate do you believe Berkshire will compound BV? (Let's just say 10% for the following exercise to make the math easy, but it can be adjusted in excel to figure out the crossover point.)

2. Will Berkshire, on average, trade at a P/B multiple greater than 1x?

3. If the answer to #1 is yes, what do you think the minimum multiple will be, on average? (Let's assume 1.25x)

4. Do your alternative investment opportunities have return profiles that will allow your distributed dividend to compound at a rate that overcomes the lost value due to distribution?

Given the above assumptions, let's say you elect to take the dividend and that BV starts at $1,000 in year 0. After earning $100 in year 1, it distributes the earnings to you, which you then reinvest at a rate of 20%. It then continues to earn 10% on book for 5 years, distributing the cash to you. How much do you have at the end?

Year 1: $100
Year 2: $100 + $100*(1 + 20%)
Year 3: $100 + $100*(1 + 20%) + $100*(1 + 20%)^2
Year 4: $100 + $100*(1 + 20%) + $100*(1 + 20%)^2 + $100*(1 + 20%)^3
Year 5: $100 + $100*(1 + 20%) + $100*(1 + 20%)^2 + $100*(1 + 20%)^3 + $100*(1 + 20%)^4

Total: $500 + $480 + $432 + $345.6 + $207.36 = $1,964.96


Alternatively, if earnings were retained, the market value of the company would be:

BV of $1000 * (1+10%)^5 = $1,610.51
P/B Multiple: 1.25x

Market Value of No-Dividend Company: $2,013.14


Bottom line: It makes sense to receive a dividend instead of earnings being retained only if you will pay no taxes on the dividends AND your alternative investment opportunities exceed 20% annual returns. The math gets significantly worse if you have to pay taxes...

-RoyalScribe
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