🔑 Why we don't pay dividends
Welcome to The Business Academy. Here's what we have in store for you today:
- Why Warren Buffett NEVER pays a dividend
- The $100m lynx fraud
- Netting $1m+ from mowing lawns
🔑 How do you get Phil Knight's attention
I talked with fitness entrepreneur Josh York, who has a unique method for getting people's attention:
He mailed Nike Founder Phil Knight a massive tire, with a note slipped in the middle (it cost more than $500 to ship)
A week later, he got his tire back from Phil, with a note and an autographed copy of his book.
And he used the same method to grab Gary Vee's attention and get on his show. You're going to want to listen to Josh and learn from him:
Why we don't pay a dividend
I run a long-term holding company called Enduring Ventures.
One of our main goals is compounding great businesses over the long-term with an indefinite holding period.
But there's a major threat to compounding: Dividends.
We don't pay out dividends.
Warren Buffett famously has the same policy. His trillion dollar company, Berkshire Hathaway, hasn't paid out a dividend since the 1960s (and Buffett says he still regrets paying out that dividend).
Warren Buffett joked that he was in the bathroom when Berkshire Hathaway made the decision to pay its only dividend in 1967. Buffett believes that reinvesting in a company's business is more valuable to shareholders than paying dividends directly. -Investopedia
What's the argument against paying dividends? There are three main ones:
- Double Taxation - Dividends are essentially taxed twice, meaning investors capital is cut down by two levels of taxes: First, corporate taxes paid on the company's profits. And then, investors pay personal tax on the dividends they receive.
- Capital Allocator Conflict - If you invest in a capital allocator, you're saying they will invest your money better than you over the long term. Cash is their hunting tool. If you take their cash away they can't hunt for the investments you asked them to hunt for in the first place.
- Equal tax hit - if dividends are issues, whether you wanted them or not, everyone is going to pay taxes on the dividends received
Companies should only pay out a dividend if they don't have a better way to put the capital to use within the business. There are many businesses that aren't able to invest their cash efficiently, and that's ok too.
The issue with dividends is they often get paid when times are good.
Then when the market turns, a buying opportunity presents itself. But the companies that distributed their cash no longer have it available to make investments at good prices.
There are better ways to achieve the purpose of a dividend without the two downsides listed above.
Buffett's preferred method is stock buybacks.
Berkshire routinely buys back a couple billion dollars worth of its own shares every quarter. Here's why:
Investors who pay taxes generally prefer buybacks because they generate no tax bill for any non-selling shareholder. Selling shareholders generally only pay the lower long-term capital gains tax.
Buybacks cause the value of all outstanding shares to go up, since there are fewer shares outstanding. Berkshire uses its huge cash pile to buy back its own shares when Buffett believes the current market price is below the intrinsic value.
Investors also have the option to sell a portion of their shares if they need liquidity, without the unfavorable tax treatment of dividends.
Remember a couple years ago when people said Buffett “lost his touch”? They were wrong.
And there’s still a lot you can learn from Buffett today.
But Berkshire owns stakes in tons of companies. What happens when those companies, like Geico insurance, pay out dividends to Berkshire?
Buffett's got a trick for that as well (that we copied).
It's called C Corp Dividend Deductions. When one C Corp owns more than 80% of any subsidiary, it can deduct ALL dividends received.
You can use those dividends to reinvest in new opportunities without paying tax on the dividends at the holding company level.
This is how Buffett moves cash from his subsidiaries to the main office to reinvest.
We collect dividends at our holding company level from the subsidiaries that are profitable enough to pay dividends, without being double-taxed.
Then we keep that capital in our holding company and deploy it into the best opportunities which allows us to compound the capital.
If you're interested in more info on the topic of our corporate structure, check out this post I did the other week.
🔑 One interesting read: Spotting red flags when buying a business
I've looked at thousands of businesses for sale.
It can be tough to know when to keep pursuing a deal despite a red flag or two (nearly every deal has a red flag - there is no perfect deal).
But how do you know when to stomp on the brakes?
M&A attorney Eli Albrecht gives a great breakdown of a deal that his client was adamant on pursuing - which ended up being a massive fraud. Give this a read:
🔑 One interesting deal: $1m+ cash flow from mowing lawns
This property maintenance company does $3 million in revenue and is selling for $1.75 million.
Let's take a look:
What I like
The multiple (1.7x cash flow) is attractive. The company has healthy margins and is well-established (I love buying companies that have been around for 30 years).
The listing mentions that the company's revenue is a mix of residential and commercial, with some builders as clients as well.
A mix of customers can be helpful to smooth out revenue. But it can also be challenging because often times Commercial and Residential clients require different processes, training and sometimes different staff skills.
What I don't like + things to explore
One potential concern is the location: Being in Tampa, I'd want to ask how much the recent hurricanes impacted the properties the company services.
Also, I'd be skeptical about tying myself too much to home builders, which the company services. Florida can be boom-or-bust in terms of new construction.
I'd also like to know why the business is listed for such a low multiple. I'd expect this to sell for at least 2x cash flow.
Have a great week,
Sieva
Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.
