S Murlidharan

The Berkshire lesson

Updated on: May 04, 2011

No company can forever fob off its shareholders with a smug exhortation to collect their rewards from the market by booking profits.

By far the world's almost unique investment company Berkshire Hathaway has had the distinction of never rewarding its shareholders explicitly, neither cash dividends nor bonus shares ever since its inception.

In fact, its legendary promoter Mr Warren Buffett has gone on record pooh-poohing bonus issue and stock splits as gimmicks though both are not in the same league (stock splits result in reduction in the face value of shares whereas issue of bonus shares results in increase in the paid-up share capitalmaking for a greater qualitative difference to the share capital of a company and to the fortunes of its shareholders.)

In India, bonus shares are looked upon with awe and admiration, as a statement of confidence by the company issuing it in its capability to service the enlarged share capital. Indeed, companies without such confidence settle for a one-time hefty special dividend because a mindless bonus issue could spell disaster on the bourses if the enlarged share capital far from beefing up the investible resources of the companies actually pulls down the Earnings Per Share (EPS).

The American distaste

The American distaste for bonus issueis well known. To heap scorn on a bonus issue as the equivalent of a stock split is to betray intellectual defiance, if not ignorance. For, even though the net worth post-bonus remains where it was pre-bonus, which is also the bottom-line on a stock split, the shareholders do end up holding greater number of shares with greater market value.

If the cum-bonus quotation for a share was Rs 1,000, its ex-bonus quotation on a 1:1 bonus is often not half as can be logically expected but in the region of say Rs 600 in a normal market fuelled by hopes of efficient use of the enlarged share capital. What was worth Rs 1,000 is now worth Rs 1,200. This is the Indian experience, but the Americans are somehow not sold on the idea and most of their financial gurus rubbish both a bonus issue and a stock split as a gimmick with there being no accretion to either the net worth or to the book value of a share.

Reward from market

A textbook solution to the dilemma of dividend is surprisingly pat and open and shut - distribute to the shareholders the available profits if they can earn more than the company itself from such money. In other words, if a company can plough back the profits into business opportunities that fetch higher returns to the company and hence to its shareholders, then prudence according to the theorists demands that cash dividend is better withheld. But the suggestion, simple as it is, begs the question - how on earth can a company find out the individual investment capabilities of shareholders who in addition are not a homogenous lot?

It would also be presumptuous on the part of a company to sit in judgment over the expectations and needs of shareholders. In the event, it is not at all surprising to find Berkshire Hathaway revisiting its dividend policy which it has been pursuing steadfastly for decades since its inception - it is contemplating a maiden cash dividend.

Rude awakening

What seems to have rudely awakened it is the dawning realisation that the market is disenchanted with its dividend policy as reflected in its market quotations that have bucked the trend for companies with similar earnings and profile. No company can forever fob off its shareholders with a smug exhortation to collect their rewards from the market by booking profits.

One hopes the humbling lesson learnt by the redoubtable Warren Buffett has a chastening effect on some of the Indian promoters who have been implicitly projecting themselves as his clone.

Besides being unabashedly self-serving, the collect-your-reward-from-market theory is fraught with the danger of hubris. What if the money ploughed back into operations does not yield higher return vis-à-vis shareholders own expectations from their home-grown investment opportunities assuming that they are a homogenous lot which of course they are not. This danger alas is all the more for an investment company than a manufacturing company, given the fact that the fortunes of the former are more inextricably linked with the fortunes of the stock market.

While churning or booking profits is the right thing to do, it does not lie in the mouth of a company to proffer this gratuitous advice, self-serving as it is. User charges cannot be begrudged whether it is an ordinary citizen using civic services such as water and electricity or it is a blue chip company serenading investors to put faith and money into its lap. A judicious mix of cash dividend and periodic bonus issue is thus what the doctor has ordered for companies.

(The author is a Delhi-based chartered accountant).

Published on May 07, 2011

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