It’s good Amazon and Buffett pay no dividends

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Local retailers have seen their shares sold off recently in a gathering fear that when Amazon comes to town it will destroy their markets and profit margins. In June, Amazon expanded into the grocery business and its shares hit $1,000 for the first time. It listed in 1997 at $23.50.

Amazon has been a fascinating company to watch but I have never bought shares in it directly. Amazon created a new global market 20 years ago – online retailing – and it has dominated the market ever since, but it has never been able to figure out how to make a profit from it. It has never paid a dividend and never plans to in the future. At first glance it sounds like a crazy business plan and a lousy investment. Surely a company that never intends to pay a dividend is a crazy gamble that can only pay off if you can find a ‘bigger fool’ to sell it to for a higher price in future.

Meanwhile Amazon shares have rocketed upward. If you invested $1,000 in Amazon shares at $23.50 on the first day of trading on 15 May 1997, your initial $1,000 would be worth $494,000 today. That’s a return of 36% per year over 20 years (Amazon shares have split 12:1 over the period). But still no dividends!

Our obsession with dividends is misplaced

Australians have always been obsessed with dividends but I would much rather invest in a company that retains its capital instead of paying it out in dividends – if it can earn a higher rate of return on its capital than I can earn if it gave the money back to me. Over the years, my best returns from shares have been in companies that never pay dividends.

For example, I have been a shareholder in Berkshire Hathaway for many years, a company controlled by the world’s greatest living investor since 1964. Under Warren Buffett the company has never paid a dividend and never plans to. Buffett and his offsider Charlie Munger can earn a higher return on the capital than I can, so they keep the capital in the company and re-invest it to grow faster than I can grow it. Returns on Berkshire Hathaway shares have beaten the broad US stock market by more than 2% per year since Amazon was listed. That’s a great result, but well behind Amazon (Berkshire shares hit $1,000 per share back in 1983 and are now $254,000 per share, and that’s US dollars!).

Amazon shareholders let its founder Jeff Bezos keep the money in Amazon and re-invest it to expand the business, just as Berkshire shareholders let Buffett and Munger keep the money to re-invest it and expand. Rather than declare profits and pay tax, Amazon chooses to spend the surplus cash to expand. That’s how it grew to be the largest retailer on the planet. It has never had to raise equity since the initial $300 million raised in the 1997 float. Likewise, the vast bulk of Berkshire’s ‘profits’ are unrealised gains on their investments. They rarely sell anything and they have financed it all internally by not paying dividends.

Amazon and Berkshire are very similar. Both have grown to be in the top 10 most valuable companies in the world by reinvesting their cash flows. Both are impossible to value as they have no real earnings and no dividends. But Amazon is running out of space. It can’t keep growing forever at the same rate (unless it invades and populates another planet or two) and Berkshire is running out of time. Buffett and Munger are 86 and 93 years old respectively.

Many investors hold both Amazon and Berkshire Hathaway indirectly in diversified portfolios because they are both in the largest dozen listed companies in the world (each is about 1% of the global stock market value) and therefore feature in global share index funds.

 

Ashley Owen is Chief Investment Officer at privately-owned advisory firm Stanford Brown and The Lunar Group. He is also a Director of Third Link Investment Managers, a fund that supports Australian charities. This article is general information that does not consider the circumstances of any individual.

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19 Responses to It’s good Amazon and Buffett pay no dividends

  1. Il Falco July 12, 2017 at 5:40 PM #

    Both companies have no real earnings? Where does the free cash come from for reinvestment?

    What do you think will happen to the free cash when neither company can compound earnings north of 10%?

    BRK running out of time? As a shareholder you will have noted the transition over the years away from Wazzas stock picking prowess to being a conglomerate operating some pretty special businesses. Does the value of these subsidiaries + stock portfolio go to zero post Wazza and Charlie or is the business worth more via spin offs? I think I know the answer.

  2. ashley July 13, 2017 at 8:42 AM #

    great point!
    Both are tremendous generators of cash flows and economic earnings, but accounting earnings are not the same thing. Fortunately accounting earnings are easy to manipulate – to reduce or defer tax. Berkshire does it by not realising gains, and Amazon does it by expensing its expansion costs.
    I’m not a seller – if i did I would pay too much tax!
    When Buffett, Munger and Bezos die their companies will live on – but probably as mature dividend paying behemoths without the same growth spark – like Apple after Jobs.

    cheers
    ashley

  3. Chris July 13, 2017 at 10:58 AM #

    Personally, I think that Buffett’s attitude that “if you need a dividend, sell the stock for some money” is pretty arrogant. It is implying that “he knows better than us” as to where to put the money generated by the company…well, the value to what he might ascribe to the money and what it can do could be remarkably different to what someone else thinks.

    For example, I might want to take a holiday or buy a luxury car, and the intangible and tangible benefits of having that would be worth every penny, if not more to me than the tangible amount of money that I spent on it – “Value is remembered long after price is forgotten”. Or I might need a life-saving medical operation…money would be no object then.

    I know that this is a very American attitude, that “if you want growth, you buy stocks. If you want income, you buy bonds” and their tax laws favour growth over dividends, but part of the idea of “living off capital” when you have finally accrued enough of it is that it throws off money as a dividend and the capital remains intact and grows above inflation, rather than having to kill the golden goose piece by piece and ending up with a tax bill anyway.

    (I believe that the former was the premise of your book about “$1 Million for Life” ?)

    • That man in really, really nice shoes July 13, 2017 at 3:04 PM #

      Chris, unsure how your returns compare to Uncle Warren’s but his 20% for 50 straight years sure beats mine. Given the fact they do better than most with the money reinvested BRK did introduce their B shares which allow holders with both not to sell an A share now worth a mint just for income and then forgo the future upside. That all said, I did see something in the Fin recently saying companies that do pay a divi actually do better longer term than those who reinvest it all in-house. And I’ve had a few where I’ve lost a bomb having DRP shares and the whole show then sank. Anyways, in Buffett’s case it’s certainly worked out well. Cheers, C.

  4. Il Falco July 13, 2017 at 11:57 AM #

    Well, I think it is pretty clear from BRK’s performance that he does know far better than us where to put the cash generated by the company.

    What is the aversion to selling stock?

    Business A ; compounds earnings at 10% , pays no dividends.
    Business B ; pays out 5% dividend and compounds earnings at 5%

    You’d sleep soundly spending dividends from B but would never sell a share of A ?

    I’m lost with this logic.

    • Chris July 13, 2017 at 1:39 PM #

      Il Falco, Ashley stated himself that “I’m not a seller – if I did I would pay too much tax!”, so my logic about spending dividends from B but would never sell a share of A seems to resonate with at least one other person for the reasons I’ve alluded to here.

  5. p July 13, 2017 at 1:17 PM #

    How do I get the $100,000 of franking credits?

  6. Chris July 13, 2017 at 1:23 PM #

    The aversion to selling stock is that you’ve killed the golden goose. If you get a dividend, you still have the asset to keep. Yes, there may be a price to pay, but it seems like a case of the tortoise and the hare because the asset that you have kept is still compounding away at that preferential 10% rate (which, we’re assuming goes to perpetuity).

    Buffet has directed that after he dies (which statistically, will probably not be that far away…let’s be realistic), the majority of his money be placed into a low cost, S&P500 index fund tracker. That seems to be the succession plan (the question of which seems to get glossed over at every AGM).

    Buffett doesn’t employ gearing, and I would therefore postulate that even with conservative (30-50% LVR) gearing with a buy and hold, tactical asset allocation against various ‘vanilla’ ETFs, that a 10% compound earnings interest rate would be easy to get over the long term (let alone beat). Given that these vanilla ETF will be where his money is heading, with gearing, it is the equivalent of jogging or running on the same track for the same investment journey distance, rather than walking as his post-BRK funds will do, comparing like with like.

    However, the industry has traditionally been geared (sic) towards active management of investments with a short time frame rather than passive, longer term time frames (although that is changing).

    Furthermore, the tax treatment of dividends versus capital gains is markedly different. Thanks to the International Tax Treaty between ourselves and the USA, the effective tax rate of income is around 15%, because it is recognised as “foreign income” (although the book title above explains this better). The problem with capital gains is that there is a very real danger that they can / would be double taxed by both the US and the Australian tax offices (as some people with US investment properties are finding out), let alone the fact that the ATO would probably not differentiate between ‘selling a foreign asset’ versus ‘selling a domestic asset’, and therefore (assuming it was not a pre-1985 asset and you had held it for more than 12 months), you would be taxed at 50% of your marginal tax rate. Especially if you’re on a high MTR, I would wager that the numbers are more in favour of receiving a dividend than a capital gain (also discounting any movements in currency).

    If the USA had dividend imputation, then the numbers look even better; again, depending on the MTR, those franking credits are valuable. The company has already paid tax on the dividend, which could mean little, no or even a tax credit on that dividend, thanks to the franking credits. They’re money in the bank. Therefore, you cannot just compare a 10% compound rate against a 5% compound rate, you need to take into account any grossed up tax credits in the equation and how the income is handled under the respective tax law / tax treaty.

    Dividends are also preferable because I can always elect to reinvest them. No dividend means that I’m not being given that choice as to what I believe the money is better spent on (as above). Also, diversification tells us that you spread your risk, not concentrate it in one or few stocks. Buffett has spoken out against diversification (calling it di-worse-ification), but apparently a tracker fund over the S&P500 is OK when he dies ? (double standards ?)

    If I elect to receive the money as a dividend, I can rebalance my portfolio from the cash balance, rather than selling what might be a perfectly good asset to do so and perhaps unnecessarily incurring a tax bill. Or, I can wait until the price of BRK comes down and buy more of it; in short, I am in control of when and how my money is invested into the company, based on my own personal circumstances, not when I am dictated to, based on what someone else believes where I should put my money.

    Assuming there’s no dog stocks in the portfolio, then selling a perfectly good asset because you need the money seems like “Burn the village to save the village”. I’m lost with that logic too.

  7. Il Falco July 13, 2017 at 3:56 PM #

    As quick as I can ;

    I think you need to take a broader view. Its all money. These are different assets. (dividend vs. compounder). One pays part of its earnings yield to you, one re-invests it – and in doing so increases its capital value (but not necessarily total shareholder return) faster. Think of it as a pool of capital, not number of shares.

    Buffett’s succession plan? What Buffett has advised his widow to do with his personal finances (excluding BRK stock) is invest in an S&P500 index and bonds 90/10. That is nothing to do with BRK’s succession plan.

    You misunderstand the tax treaty – US applies a 15% withholding tax on dividends. Due to the double taxation treaty, that 15% included in your AU return before top up tax (to your marginal rate) is applied. A top bracket tax payer would have an effective rate rate of 48(?)% on dividends allowing for the withholding tax.

    Capital gain on the other hand would pay half that allowing for 12 month holding discount. (24%).

    I dont see how including imputation is helpful or relevant to this discussion.

    Dividends create tax events outside of the control of shareholders – as an accumulator on TMR I’d much rather compound without tax burn and decide when I want to take my money off the table.

  8. Peter Thornhill July 13, 2017 at 5:12 PM #

    Imputation isn’t helpful or relevant?
    OK. I’ll take your advice and forego the $100,000.

    • Il Falco July 13, 2017 at 5:39 PM #

      Thanks Peter, we are talking about US stocks.

      Apples and oranges etc.

      Irrelevant to this discussion.

      • Peter Thornhill July 15, 2017 at 3:22 PM #

        Irrelevant? I’m sure Warren Buffett and Charlie Munger would have something to say if all those companies they invest in decided to follow his lead and all stop paying dividends.

      • Kevin July 15, 2017 at 3:49 PM #

        I agree Il falco.Buffett is great and correct.They do not have franked dividends which to me makes a big difference. To get money out you need to sell the stock and pay the CGT.Apples and oranges,two different tax regimes.Once it is sold you have no further interest in the company.

        I did exactly the same as Buffett,only with CBA.Buffett uses divi from say Amex to buy shares in Wells to buy shares in coke and so on.I am not that clever,divi from CBA buys shares in CBA.A stock that cost say $6 in 1992 paid a 40 cent dividend.Using the DRP I now have say 3 shares in CBA worth circa $250 and producing $12.60 in dividends,that seems great to me.

        If I have say $1 million in CBA then $70 K income grossed up,if I last 10 more years then a minimum (probably) of $700k is coming my way.Beats the hell out of selling them to get money.

        Two different countries,two different tax regimes,I think the end result in Australia is better.They cannot be compared just by looking at stock prices.

  9. Il Falco July 15, 2017 at 7:39 PM #

    Sorry Peter, are we talking about imputation or dividends here now? Your comment is obtuse. But anyway, 2/3rds of cash flow is generated by owned subsidiaries and the remaining listed holdings are acquired typically for growth characteristics, with dividends a healthy benefit allowing for subsequent capital allocation by Warrren and Charlie, and more recently Coombs and Weschler. This is a discussion around BRK, not about dividends.

    If one doesn’t approve of BRKs dividend policy, I believe they may well be able to find some other investment opportunities in the public markets.

    • Peter thornhill July 16, 2017 at 9:56 AM #

      Dividends primarily; imputation is the cream on the scone and jam.
      Buffet is a unique individual whom I admire greatly but fundamentally, the US market is no different to any other. If the Buffett model is the standout then why have most successful listed US companies paid dividends?
      I agree about the tax system differences but it wasn’t that long ago that we laboured under a double tax system.
      My experience tells me that the majority of retirees have neither the skill nor the stomach for making sell decisions to fund retirement and we can’t all invest in Berkshire. Out of interest, I’ve started a chat with Gluski, Gooch and Milner to see how they feel about turning their LIC’s into BRK clones.
      If it is the difference between the US/AUS tax system that allows Buffett to get away with hoarding the cash I can see little point in lauding the system here.

  10. Il Falco July 17, 2017 at 10:50 AM #

    Ok, not sure where this is going now, I didnt make a case that companies should not pay dividends, so not sure where that comes from? BRK is pretty unique, but a good number of other US “compounders” have paid no dividends and totally shot the lights out – Markel, the Liberty Companies under Malone, and Teledyne under Henry Singleton spring to mind.

    I agree that most businesses should pay dividends, it does enforce a level of capital discipline….however, I can make a distinction in the case of what are really investment holding companies.

    Interestingly, Gluskie provides a bonus share plan – maybe ask him what thats about?….compounding earnings internally without top up tax? 🙂

    Again, not sure what thats about, you play the playing field as it is.

    • Peter Thornhill July 17, 2017 at 3:07 PM #

      Agree. Investing is not about the rate of return; it is about ‘does it suit you’. I leave it with words from a wiser man than I.
      It’s far too simplistic to take an output like dividends, and assume paying or not paying them is the differentiator between a good and bad investment.

      The hard truth is that there are both good and bad businesses that pay dividends and good and bad business that don’t pay dividends.
      If a company has great reinvestment opportunities at high rates of return they may (in some circumstances) do well by retaining profits, as he points out.
      However there are also many times company executives think they have “great reinvestment opportunities”, only to discover that the activities they reinvest in are less favourable, or indeed fail. One of the statistically consistent quirks of human nature and business is that when conditions look most favourable everyone (including business execs and investors) want to increase their production/reinvest more in the sector, which ultimately leads to oversupply of the good or service and a collapse in profits. This is exactly why the profit margins of businesses rise and fall.
      Further it is obvious that out of the list of companies who don’t pay dividends, there will be many who either can’t pay dividends because they are on the point of collapse or because they are shoring up fragile or collapsing businesses.

      Amazon and Berkshire are examples of where retention of capital has been of assistance. Berkshire makes money by being a provider of capital, particular when others can’t. Having spare capital is part of its business. The reason Amazon retains capital is quite different though. It is a rapidly growing business that has had to retain cash flow to fund the growth. It is only now starting make profits. It is only in future if it continues to make profits over many years that we can determine if the initial investment was worthwhile. But there’s certainly many other examples where the retention of profits has been unproductive. Consider BHP & RIO reinvesting profits in increased production in 2007 because margins and the super-cycle outlook at the time looked so strong only to find that demand wasn’t so strong and overproduction crushed prices.

      The real reason for the difference in retaining profits or paying out dividends are tax regimes. In Aust prior to dividend imputation it was disadvantageous for investors to receive and be double taxed on dividends. Accordingly company’s retained profits at that time. Because dividend imputation sensibly prevents the double taxing of company profits, Aust companies now are more balanced in their decision to retain profits or pay dividends. The US does not adopt imputation, and accordingly there remains a motivation there to retain profits.

      At a theoretical level the Australian position tends to encourage greater investment rigour:
      • If companies are agnostic to whether they retain profits or pay dividends, and/or have to separately raise capital for reinvestment, they generally have to make a good case for the quality of their reinvestment opportunities.
      • If companies automatically retain profits, loose money problems may arise. That is, there may be a tendency to spend money unwisely, and there may be too much money chasing too few opportunities.

      Il Falco, in relation to his last comment above, you were able to give me a few more examples of retained earnings working but I’m sure you are aware of the horrendous corporate malfeasance that has occurred as a result of the misuse of same.

  11. Il Falco July 17, 2017 at 3:34 PM #

    Peter, yes we are absolutely on the same page as far as agency risk of professional managers, and that this lack of alignment, combined with short term stock incentives, perhaps combined with flush coffers (pro-cyclical) leads to potentially diabolical shareholder outcomes!

    My point earlier around dividends vs. capital was merely to explain the simple arithmetic of what i see as the false logic of deeming selling compounder stock “depleting the nest egg” vs. spending dividends “safe” that one poster presented. I think we need to think more broadly about this – particularly, touching on the tax considerations you raise, given the current favour in the US markets for on market stock buy-back as a means of shareholder return.

  12. Peter Thornhill July 19, 2017 at 12:44 PM #

    Please see my more detailed comment and chart in new article posted on the Cuffelinks website.

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