‘I do believe in dividends’: Warren Buffett once shared his dividend test for maximizing profit and shareholder return — do your stocks pass?

“I do believe in dividends in a great many situations, including many of the ones at companies in which we own stock,” Buffett responded. However, he had one key test to figure out whether it makes sense for a company to pay a dividend or not.

Here’s a closer look at that test and why it’s an integral part of the Oracle of Omaha’s investment philosophy.

Buffett’s dividend test

“The test about whether to pay dividends is whether you can continue to create more than $1 of value for every dollar you retain,” Buffett said. In other words, a company should probably pay a dividend when they do not have any opportunity to reinvest retained earnings profitably.

Buffett uses See’s Candies as an example. He acquired the candy maker in 1972 for $25 million and has often called it a “dream business.” However, he believes the company doesn’t have many opportunities to reinvest in the business and create additional value, which is why he prefers taking a hefty dividend from this subsidiary.

“We like the companies in which we have investments to pay to us the money they can’t use efficiently in their own business," he says.

Berkshire Hathaway, on the other hand, can use excess capital effectively. Buffett’s investment prowess has delivered a 19.8% compounded annual return from 1965 to 2023, compared to the S&P 500’s 10.2% compounded annual return over the same period. This is why he believes Berkshire shareholders are better served when he retains all the company’s earnings and reinvests it rather than paying it out as dividends.

Applying this test to a couple of Buffett’s top dividend stocks highlights its value for investors.

Apple

The iPhone maker dominates Buffett’s portfolio. Even after he sold half his stake earlier this year, it’s still his largest holding.