Berkshire Hathaway's Dividend Obsession

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Berkshire Hathaway's Dividend Obsession
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Berkshire Hathaway's Dividend Obsession

Since it was disclosed that Warren Buffett's Berkshire Hathaway now owns nearly $11 billion in shares of IBM, many in the media, including the Wall Street Journal, are speculating about why  Warren Buffett might suddenly be reversing his stance on technology stocks.

You may remember that Buffett is famous for shunning tech stocks -- mostly because he wisely avoids things he doesn't understand well. As a deep value investor, understanding a company's operations as well management's particular skills and intentions are key. That has always been difficult in the tech sector where technologies are disrupted constantly and management turnover is high.

But all of the headlines you have read about Buffett changing course on tech stocks may miss an important point. Take a look at Berkshire's portfolio of publicly-traded equities below, prepared by Forbes chief statistical editor, Scott DeCarlo.

As you can see 27 of Berkshire Hathaway's 33 stock holdings pay cash dividends. Add it all up and Berkshire Hathaway (BRK.A) should bring in at least $1.4 billion in cash dividends on annual basis from its equity holdings.  

IBM (IBM) should provide $172 million assuming that it doesn't raise or lower its payout. Coca Cola (KO) will contribute a whopping $376 million over the year to Berkshire's coffers (Berkshire is holding about $35 billion in cash).

So forget all the hubbub about Warren Buffett reversing his stance on tech stocks. Think dividends. What is special about IBM and Intel (INTC) among tech stocks is that these are both big, mature and stable industry leaders who are returning value to shareholders in the form of cash.

Buffett's apparent obsession with dividend payers is somewhat ironic given that Berkshire Hathaway continues to eschew paying out cash to its own shareholders.  Most likely for tax reasons, Buffett is a stock buyback man. If you would like to read a great explanation of why you should consider Berkshire's share repurchases as a valuable tax-free dividend, please read my colleague Bill Baldwin's article, "Berkshire's Clever Tax-Free Dividend."

I wonder if Berkshire Hathaway's portfolio would change if dividends' preferential tax treatment came to an end. For individuals, most of these cash payouts are considered "qualified dividend income" and get a reduced 15% tax rate. This beloved investor benefit is set to expire at the end of 2012 with other Bush tax cuts.

Corporations like Berkshire get to deduct the vast majority of the dividend income they receive from other companies because of something called the "dividend received deduction", or DRD. The idea is to eliminate triple-taxation for investors and the deductible amount ranges from 70% to 100% depending on how much of the outstanding stock is owned. Thus Berkshire's effective tax rate on dividend income is probably 10% or less.

If the taxation of dividends were to go up for corporations, one wonders if Buffett would sell some of his current "my time horizon is forever" stocks. Wal-Mart (WMT) might be a candidate. The stock price has gone nowhere in the last decade and it seems to be struggling to regain its retailing mojo. But boy its $56 million in dividends checks annually to Berkshire are nice.

Knowing the kind of weight Warren carries in the capital markets, I bet that in the event of a serious hike in dividend taxes he might be able to convince a few of "his" CEOs to transform their own cash dividend payouts into more aggressive stock buybacks.

Click here for 10 Large Cap Stocks With Fat Dividends

 

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