INTELLIGENT INVESTING INVESTING PERSONAL FINANCE BOOKS ASK MIKE? ABOUT DISCLAIMER Why Investing In Companies with High Returns On Capital and A+ Financial Ratings Versus Focus On Dividend Payments May Be More Important? POSTED BY: INTELLIGENTINVESTING.COM APRIL 29, 2019 I am often asked all the time about dividends by colleagues and my children with a goal finding great dividends as source of income for investing and retirement. Yes you need income, but buying a stock just because it pays a dividend may not be the best long term strategy. If you focus on dividends alone you may be in for a surprise about how this can hamper long term investment results. My unconventional, view is a company’s free cash flow and a long history of above average returns on capital and equity are what are more important than high levels of dividend payments to achieve long term dividend income. Often companies with significant amounts of free cash flow, A+ financials, and high returns on equity and capital do not pay little to if any dividends. You do not need a dividend to get the impact of a dividend. Contrary you can get your desired dividend income by selling 5% of your holdings every year. The following article is to outline that investments in high return on capital and free cash flow companies do very well over long periods of time and using an approach to sell off 5% every year has long term investment advantages and can still preserve desire for dividend income. To prove the above statement let’s take the example of a company with no dividend and a high level of free cash flow and by design owning assets with high returns on invested capital. The company I am highlighting is Berkshire Hathaway. This is a company that produces in the range of $2-3 billion per month of free cash flow. When you look at underlying businesses and stocks purchased they produce returns on capital employed often greater than 20%. In the 2018 Berkshire Hathaway annual report, Warren alludes to impact of high returns on capital when he discusses stock holdings: “What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning about 20% on the net tangible equity capital required to run their businesses. These companies, also, earn their profits without employing excessive levels of debt.” To see the results of investing in a stock without a dividend, yet selling off 5% of your holdings every year is look at how this has impacted Warren Buffets personal holdings which in 2006 he started gifting to several charitable foundations. At the start of Warren’s charitable gift giving (End of 2005) he owned roughly 34% of Berkshire Hathaway with a market value of approximately $44 billion. Each year through 2018 Warren has gifted approximately on average 5% of his stock to his designated charitable foundations. By the end of 2018 through 5% average annual charitable contributions his stock ownership in Berkshire Hathaway was reduced to approximately 16.5% (reduced over 50% of his stock holdings since he started gifting stock in 2005), yet the value of his 16.5% holdings by year end 2018 had increased $83 Billion. The reason this happens I will argue is the high free cash flow and high return on capital characteristics of company like Berkshire over a long period of time double the value of Buffett Berkshire holdings yet owns half of what he started with. These 5% annual charitable gifts are no different than selling 5% of one’s stock each year. The transfer of shares was executed in middle of some significant moves (up and down) in stock market prices including the 2008 credit crisis. Yet over time as his shares decreases as he gave away 5%, the remaining shares significantly increases because of the strong financial free cash flow performance of Berkshire Hathaway. You can argue this phenomenum was driven by long time honored approach to buying assets at the right price. Assuming he gave away another 5% in 2018 and the stock closed at 304,000 per A Share at year end 2018 his value increased to $83 billion. This leaves the question: What is really important when thinking about income for retirement? Buying companies with high returns on capital, free cash flow, and A+ financials or focused solely on dividend payment %? Facebook Twitter LinkedIn Email Next post BE THE FIRST TO COMMENT ON "WHY INVESTING IN COMPANIES WITH HIGH RETURNS ON CAPITAL AND A+ FINANCIAL RATINGS VERSUS FOCUS ON DIVIDEND PAYMENTS MAY BE MORE IMPORTANT?" Leave a comment Your email address will not be published. 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