Why Warren Buffett Loves Dividends, but Doesn’t Pay Any

Berkshire Hathaway has a portfolio full of dividend stocks, but it doesn’t pay a dime to its shareholders.

Warren Buffett loves getting dividends from the stocks he invests in, and he has invested a considerable amount of Berkshire Hathaway’s (NYSE:BRK-A)(NYSE:BRK-B) capital in dividend-paying stocks, particularly in those that consistently increase their payments every year. In fact, the stocks in Berkshire’s portfolio will pay the company more than $880 million in dividends during the second quarter of 2017 alone.

Despite Buffett’s love of dividends, Berkshire Hathaway has never paid one to its shareholders, nor does Buffett plan to start implementing a dividend anytime soon. This may seem like a big contradiction — as Buffett himself said in his 2012 letter to Berkshire shareholders, “It puzzles them [some of Berkshire’s shareholders] that we relish the dividends we receive from most of the stocks Berkshire owns, but pay out nothing ourselves.” However, Buffett’s reasoning makes perfect sense.

Why doesn’t Berkshire pay a dividend?

To understand why Buffett loves dividends so much, it helps to know why Berkshire itself doesn’t pay a dividend to its shareholders. In the same letter to shareholders I referred to a moment ago, Buffett laid out his priorities when it comes to the cash generated by Berkshire’s business activities.

The billionaire’s first priority will always be to deploy cash as needed in Berkshire’s existing businesses. This includes things like bolt-on acquisitions and investments in business assets. However, there is typically a lot of cash left over after its current operations are taken care of.

Buffett’s second priority is to search for new acquisitions, unrelated to its current business. A good example is the acquisition of Precision Castparts in 2016. Buffett and his team look for acquisitions that are “likely to leave our shareholders wealthier on a per-share basis than they were prior to the acquisition.” Buffett adamantly defends his acquisition record, saying that shareholders are far wealthier today than if some of Berkshire’s acquisition capital had been spent on dividends instead. Looking at Berkshire’s book value gains over the years, it’s tough to argue with this.

Third, Buffett looks to use Berkshire’s cash to repurchase its own shares, but if and only if they are trading at a “meaningful discount to conservatively calculated intrinsic value.” The company currently defines its buyback threshold as 120% of book value, and the stock trades for 145% of book value as I write this.

Essentially, these are the three ways Buffett is currently willing to use Berkshire’s capital. If none of the three options look appealing, Buffett is perfectly content with adding to Berkshire’s stockpile of cash and waiting until one of the options becomes attractive. In fact, Berkshire has a stockpile of about $86 billion as of the end of 2016, so it’s fair to say that Buffett and his team are willing to wait for the right opportunities to come along.

So, why does Buffett love dividend stocks so much?

In a nutshell, Buffett loves dividend-paying stocks for the same reason he loves most of the businesses Berkshire owns. They generate cash, which can be put to use in whatever way Berkshire needs at the time. Here’s a list of some of Berkshire highest-dividend stocks currently in its portfolio.

For example, if one of Berkshire’s subsidiary businesses needs to upgrade its equipment, the latest dividend check received from Coca-Cola can help finance it. Or, if Berkshire’s stock is trading at a price level management perceives as “cheap”, the company can use its dividend income to repurchase shares. Another possibility is to add dividend income to the company’s stockpile of cash to help finance its next big acquisition.

Buffett loves dividend stocks, especially those that pay dividends consistently and make an effort to raise the payout year-after-year, because they provide a consistent source of cash flow that Berkshire can deploy in whatever way it sees fit.

Matthew Frankel owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.