Berkshire Hathaway had two classes of sharesClass A and Class Btrading on the New York Stock Exchange. As of January 24, 2018, approximately 11 per cent of the Class A shares were held by members of the general public; 48 per cent were held by institutions and 41 per cent by insider investors. At the end of 2017, the average price of Berkshire Hathaways Class A stocks was $297,600 per share. The Class B shares were created in 1996. They gave the Class A shareholders the right to convert each Class A share into 30 Class B shares. On January 21, 2010, each Class B share was split into 50 shares. As of January 24, 2018, approximately 35 per cent of Berkshire Hathaways Class B shares were held by members of the general public; 47 per cent were held by institutions and 19 per cent by insider investors. At the end of 2017, the average price of Berkshire Hathaways Class B stocks was $200 per share.

DIVIDEND POLICY

Buffetts strategy was to make it a priority to diligently reinvest earnings in the companys existing multi-sector businesses. In 2012, Berkshire Hathaway made capital expenditures of $12.1 billion in current businesses and new acquisitions. Buffets principles were articulated in a two-step priority, which made it clear that funds would not be used for dividend payments: (1): The first priority with available funds would always be to evaluate whether they could be diligently reinvested in the existing businesses; (2): The next step was to search for acquisitions unrelated to the current businesses.

Buffet considered another valid use of funds to be share repurchase at a fair price. The company employed a share repurchase option under which the shares would be repurchased at a premium, up to 120 per cent of book value. Buffett considered the share repurchase option to be a better alternative to a dividend payment.

Example

To emphasize why the repurchase option might be better, Buffett provided an example with two scenarios. Assume there were two equal owners of a business with a net worth of $2 million. If the return on net worth was 12 per cent per annum, the earnings would be $240,000 per year. Assume there also existed a buyer who had agreed to buy into the company at a value of 125 per cent of net worth. The offer thus implied that the market value for the company would be $2.5 million and each individual share would be worth $1.25 million.

Scenario A: Pay Out One-Third of the Earnings as a Dividend and Reinvest the Remaining Two-Thirds

This scenario reflected the preference of investors who wanted a balanced investment policy that catered to both current income and capital appreciation.

In year zero, one-third of the earnings ($240,000 ¹/₃ = $80,000) would be paid to the owners as a dividend, which gave each of them an income of $40,000. After payment, the company would be left with $160,000 to reinvest in the business. Earnings would continue to grow, and dividends would increase proportionately. Thus, dividends and earnings would grow by 8 per cent per annum (12 per cent earned on net worth less 4 per cent paid out from net worth). After 10 years, the companys net worth would be $4,317,850the result of the original $2 million compounded at 8 per cent per annum. The dividend payment would be $86,357. The market value of each individuals holding would be $2,698,656.

Scenario B: Sell Off

This scenario reflected Buffets philosophy and was followed by Berkshire Hathaway.

Under this scenario, there would be no dividend payment and the entire earnings would be reinvested in the business. In order to maintain an income without dividends, each owner would sell 3.2 per cent of their respective holding. Based on the prospective buyers offer, the sale would earn 125 per cent of the shares book value. So, in year zero, each owner would be able to earn the same $40,000 from the sale of shares ($2.5 million 3.2 per cent 2). At the same time, the entire earnings of $240,000 would be reinvested in the company, which has a growth rate of 12 per cent per annum. After 10 years, the companys net worth would be $6,211,696the result of the original $2 million compounded at 12 per cent per annum. Because the owners had been selling shares each year, the percentage of each owners share would have dropped. After 10 years, each owner would hold 36.12 per cent of the business, which would amount to a value of $2,243,665. The market value would be 125 per cent of the net worth, meaning the market value of the individual shares would amount to $2,804,425.

Thus, the sell-off scenario, while providing the owners with their required income, added more value to the capitalapproximately $105,770 more than with the dividend scenario.

Buffets other argument against paying dividends considered the needs of individual shareholders. When a company paid a dividend, it decided the amount that each shareholder would receive. Thus, dividend payments permitted the company to decide the shareholders income. For example, if a company decided to pay out 40 per cent of the earnings, any shareholder who wanted income amounting to 50 per cent or 60 per cent would be dismayed. The sell-off option, however, allowed shareholders to sell their shares in accordance with their income requirement.

To reassert the philosophy of sell off as a substitute for dividend, Buffett revealed that from 2005 until 2012, he had annually divested 4.25 per cent of his shares. Thus, his original holdings of 712,497,000 B- equivalent shares were decreased to 528,525,623 sharesa loss of almost 26 per cent. However, even though the percentage of Buffets ownership had decreased, the book value of his holdings had increased significantly from $28.2 billion for 2005 to $40.2 billion for 2012a gain of over 140 per cent.³⁶

CURRENT FACTORS INFLUENCING THE DIVIDEND DECISION

As of the end of 2017, Berkshire Hathaway was in possession of $115.95 billion in cash and short-term investments. A portfolio manager calculated that Berkshire Hathaway was in a position to pay a one- time dividend of $20 billion and still be left with enough cash to cover future investment requirements. Buffet had said that his inclination was toward share repurchase instead of a cash dividend payment because a dividend payment implied a promise of payment forever.⁴² However, Berkshire Hathaways share repurchase offer was applicable only when shares hit 120 per cent of book value, and early in 2018, both the Class A and Class B shares were trading near 170 per centfar above the companys limit for repurchase.

question

Considering the history of Berkshire Hathaway and Buffets historical investment strategy, what would you recommend the company do with almost $116 billion in cash and cash-equivalent reserves? Are Buffets strategic reasons for not paying dividends sustainable? Is the companys share repurchase plan still a viable alternative to a dividend? Looking at Berkshire Hathaways financials (see Exhibits ), if you were in Buffets position, would you alter the dividend policy or leave it unaltered?

EXHIBIT 2: BERKSHIRE HATHAWAY BALANCE SHEET, 20132017 (IN US$ MILLIONS) e e e e 2013 2014 2015 2016 2017 Assets Cash & Short-Term Investments 63,269 71,730 86,370 115,954 48,186 33,323 Total Accounts Receivable 34,418 36,075 40,3972 42,326 Inventories 9,945 10,236 11,916 15,7272 16,1872 Total Current Assets 91,454 107,923 119,721 142,494 174,4672 Property, Plant & Equipment Gross 159,261 179,426 190,972 202,9912 214,248 42,182 45,806 50,218 56,029 Accumulated Depreciation Net Property, Plant & Equipment 37,0472 122,214 137,244 145,166 152,7732 158,219 Total Investments and Advances 177,858 180,150 182,990 178,098 204,975 Intangible Assets 66,194 70,655 72,505 113,572 114,440 e Other Assets 27,2112 30,214 31,875 33,9172 49,994 Total Assets 484,931 526,186 552,257 620,854 702,095 6,634 8,283 1,989 12,350 19,8932 Liabilities & Shareholders' Equity Short-Term Debt & Current Portion Long-Term Debt Accounts Payable Total Current Liabilities 35,042 37,835 44,469 40,223 48,506 31,271 33,260 35,903 55,796 47,392 65,590 71,926- 82,300 89,294 82,694 Long-Term Debt Deferred Taxes 57,739 61,235 63,126 77,944 56,607 e Other Liabilities 92,648 101,492 114,944 119,865 155,044 Total Liabilities 260,446 283,159 293,630 334,495 350,141 35,480 35,628 35,689 35,702 Shareholders' Capital Retained Earnings 35,5812 204,589 e 186,410 219,922 247,312 312,594 2,595 2,857 3,077 3,358 3,658 Accumulated Minority Interest Total Equity Liabilities & Shareholders' Equity 224,485 243,027 286,359 351,954 258,627 552,257 484,931 526,186 620,854 702,095 Page 9 9B19N007 EXHIBIT 3: BERKSHIRE HATHAWAY STATEMENT OF PROFIT AND LOSS, 2013-2017 (IN US$, MILLIONS EXCEPT EARNINGS PER SHARE) 2013 2014 2015 2016 2017 179,770 194,864 209,995 222,935 241,419 138,636 149,594 157,051e 169,146 197,662 41,134 45,270 52,944 53,789 43,757 Sales/Revenue Cost of Goods Sold (COGS) including Depreciation & Appreciation Gross Income Selling, General & Administrative (SGA) Expenses Earnings Before Interest & Taxes Unusual Expense 11,9172 13,7212 15,309 18,217 18,181 29,217 31,549 37635 35572 25,576 -2,380 1912 -9482 -669 -7182 Equity in Affiliates (Pre-Tax) -122 9232 2,938- Interest Expense 2,801 3,253 3,5152 3,497 5,394 Pre-Tax Income 28,796 28,105 34,946 33,667 23,838 Income Tax 8,9512 7,935 10,532 9,240 -21,515 Consolidated Net Income 19,845 20,170 24,414 24,427 45,3532 Minority Interest Expense 369 2982 3312 3532 4132 Net Income 19,476 19,872 24,0832 24,074 44,940 19,476 19,872 24,0832 24,074 44,940 19,476 19,872 24,0832 24,074 44,940 Net Income After Extra-ordinaries Net Income Available to Common Shareholders Earnings per Share (Basic) Earnings per Share (Diluted) 7.9 8.06 9.772 9.76 18.22 7.92 8.06 9.772 9.76 18.22 EXHIBIT 4: BERKSHIRE HATHAWAY STATEMENT OF CASH FLOW, 20132017 (IN US$ MILLIONS) 2013 2014 2015 2016 2017 45,353 9,1884 Operating Activities Net Income before Extra-ordinaries Depreciation, Depletion & Amortization Other Funds Funds from Operations Changes in Working Capital Net Operating Cash Flow -952- 19,845 6,508 -3,692 22,661 5,043 27,704 20,170 7,370 -3,916 23,624 8,386 32,010 24,414 7,779 -8,622 23,571 7,920 31,491 24,427 8,901 -7,714 25,614 6,921 32,535 53,5894 -7,8134 45,776 -11,708- Investing Activities Capital Expenditures Net Assets from Acquisitions Purchase/Sale of Investments -11,087 -6,431 -8,971 -1,700 -15,185 -4,824 -400 -16,082 -4,902 -7,495 -14 492 -28,001 -12,954 -31,399 -39,678 -726 -181 Other Uses Other Sources Net Investing Cash Flow -2,708 -23,252 -5,125- 1,702 -41,091 654 490 1,221 -19,369 -27,535 -84,267 Financing Activities Issuance/Reduction of Debt, Net Other Funds Net Financing Cash Flow 3,985 -3,024 961 3,996 -1,265 2,731 4,036 -233 3,803 12,679 112 -1,277 -1214 -1,3982 12,791 -289 -165 Exchange Rate Effect Net Change in Cash 64 1,194 -172 -39,113 248- 3,5352 15,083 7,128 EXHIBIT 2: BERKSHIRE HATHAWAY BALANCE SHEET, 20132017 (IN US$ MILLIONS) e e e e 2013 2014 2015 2016 2017 Assets Cash & Short-Term Investments 63,269 71,730 86,370 115,954 48,186 33,323 Total Accounts Receivable 34,418 36,075 40,3972 42,326 Inventories 9,945 10,236 11,916 15,7272 16,1872 Total Current Assets 91,454 107,923 119,721 142,494 174,4672 Property, Plant & Equipment Gross 159,261 179,426 190,972 202,9912 214,248 42,182 45,806 50,218 56,029 Accumulated Depreciation Net Property, Plant & Equipment 37,0472 122,214 137,244 145,166 152,7732 158,219 Total Investments and Advances 177,858 180,150 182,990 178,098 204,975 Intangible Assets 66,194 70,655 72,505 113,572 114,440 e Other Assets 27,2112 30,214 31,875 33,9172 49,994 Total Assets 484,931 526,186 552,257 620,854 702,095 6,634 8,283 1,989 12,350 19,8932 Liabilities & Shareholders' Equity Short-Term Debt & Current Portion Long-Term Debt Accounts Payable Total Current Liabilities 35,042 37,835 44,469 40,223 48,506 31,271 33,260 35,903 55,796 47,392 65,590 71,926- 82,300 89,294 82,694 Long-Term Debt Deferred Taxes 57,739 61,235 63,126 77,944 56,607 e Other Liabilities 92,648 101,492 114,944 119,865 155,044 Total Liabilities 260,446 283,159 293,630 334,495 350,141 35,480 35,628 35,689 35,702 Shareholders' Capital Retained Earnings 35,5812 204,589 e 186,410 219,922 247,312 312,594 2,595 2,857 3,077 3,358 3,658 Accumulated Minority Interest Total Equity Liabilities & Shareholders' Equity 224,485 243,027 286,359 351,954 258,627 552,257 484,931 526,186 620,854 702,095 Page 9 9B19N007 EXHIBIT 3: BERKSHIRE HATHAWAY STATEMENT OF PROFIT AND LOSS, 2013-2017 (IN US$, MILLIONS EXCEPT EARNINGS PER SHARE) 2013 2014 2015 2016 2017 179,770 194,864 209,995 222,935 241,419 138,636 149,594 157,051e 169,146 197,662 41,134 45,270 52,944 53,789 43,757 Sales/Revenue Cost of Goods Sold (COGS) including Depreciation & Appreciation Gross Income Selling, General & Administrative (SGA) Expenses Earnings Before Interest & Taxes Unusual Expense 11,9172 13,7212 15,309 18,217 18,181 29,217 31,549 37635 35572 25,576 -2,380 1912 -9482 -669 -7182 Equity in Affiliates (Pre-Tax) -122 9232 2,938- Interest Expense 2,801 3,253 3,5152 3,497 5,394 Pre-Tax Income 28,796 28,105 34,946 33,667 23,838 Income Tax 8,9512 7,935 10,532 9,240 -21,515 Consolidated Net Income 19,845 20,170 24,414 24,427 45,3532 Minority Interest Expense 369 2982 3312 3532 4132 Net Income 19,476 19,872 24,0832 24,074 44,940 19,476 19,872 24,0832 24,074 44,940 19,476 19,872 24,0832 24,074 44,940 Net Income After Extra-ordinaries Net Income Available to Common Shareholders Earnings per Share (Basic) Earnings per Share (Diluted) 7.9 8.06 9.772 9.76 18.22 7.92 8.06 9.772 9.76 18.22 EXHIBIT 4: BERKSHIRE HATHAWAY STATEMENT OF CASH FLOW, 20132017 (IN US$ MILLIONS) 2013 2014 2015 2016 2017 45,353 9,1884 Operating Activities Net Income before Extra-ordinaries Depreciation, Depletion & Amortization Other Funds Funds from Operations Changes in Working Capital Net Operating Cash Flow -952- 19,845 6,508 -3,692 22,661 5,043 27,704 20,170 7,370 -3,916 23,624 8,386 32,010 24,414 7,779 -8,622 23,571 7,920 31,491 24,427 8,901 -7,714 25,614 6,921 32,535 53,5894 -7,8134 45,776 -11,708- Investing Activities Capital Expenditures Net Assets from Acquisitions Purchase/Sale of Investments -11,087 -6,431 -8,971 -1,700 -15,185 -4,824 -400 -16,082 -4,902 -7,495 -14 492 -28,001 -12,954 -31,399 -39,678 -726 -181 Other Uses Other Sources Net Investing Cash Flow -2,708 -23,252 -5,125- 1,702 -41,091 654 490 1,221 -19,369 -27,535 -84,267 Financing Activities Issuance/Reduction of Debt, Net Other Funds Net Financing Cash Flow 3,985 -3,024 961 3,996 -1,265 2,731 4,036 -233 3,803 12,679 112 -1,277 -1214 -1,3982 12,791 -289 -165 Exchange Rate Effect Net Change in Cash 64 1,194 -172 -39,113 248- 3,5352 15,083 7,128