4 / 12 | 67% + >> Scenario A: Pay Out One-Third of the Earnings as a Dividend and Reinvest the Remaining Two-Thirds This scenario reflected the preference of investors who wanted a balanced investment policy that catered to both current income and capital appreciation. In year zero, one-third of the earnings ($240,000 3 = $80,000) would be paid to the owners as a dividend, which gave each of them an income of $40,000. After payment, the company would be left with $160,000 to reinvest in the business. Earnings would continue to grow, and dividends would increase proportionately. Thus, dividends and earnings would grow by 8 per cent per annum (12 per cent earned on net worth less 4 per cent paid out from net worth). After 10 years, the company's net worth would be $4,317,850-the result of the original $2 million compounded at 8 per cent per annum. The dividend payment would be $86,357. The market value of each individual's holding would be $2,698,656. Scenario B: Sell Off This scenario reflected Buffet's philosophy and was followed by Berkshire Hathaway. Under this scenario, there would be no dividend payment and the entire earnings would be reinvested in the business. In order to maintain an income without dividends, each owner would sell 3.2 per cent of their respective holding. Based on the prospective buyer's offer, the sale would earn 125 per cent of the shares' book value. So, in year zero, each owner would be able to earn the same $40,000 from the sale of shares ($2.5 million 3.2 per cent 2). At the same time, the entire earnings of $240,000 would be reinvested in the company, which has a growth rate of 12 per cent per annum. After 10 years, the company's net worth would be $6,211,696the result of the original $2 million compounded at 12 per cent per annum. Because the owners had been selling shares each year, the percentage of each owner's share would have dropped. After 10 years, each owner would hold 36.12 per cent of the business, which would amount to a value of $2,243,665. The market value would be 125 per cent of the net worth, meaning the market value of the individual shares would amount to $2,804,425. Thus, the sell-off scenario, while providing the owners with their required income, added more value to the capital approximately $105,770 more than with the dividend scenario. 34 Buffet's other argument against paying dividends considered the needs of individual shareholders. When a company paid a dividend, it decided the amount that each shareholder would receive. Thus, dividend payments permitted the company to decide the shareholder's income. For example, if a company decided to pay out 40 per cent of the earnings, any shareholder who wanted income amounting to 50 per cent or 60 per cent would be dismayed. The sell-off option, however, allowed shareholders to sell their shares in accordance with their income requirement." 35 To reassert the philosophy of sell off as a substitute for dividend, Buffett revealed that from 2005 until 2012, he had annually divested 4.25 per cent of his shares. Thus, his original holdings of 712,497,000 B- equivalent shares were decreased to 528,525,623 shares a loss of almost 26 per cent. However, even though the percentage of Buffet's ownership had decreased, the book value of his holdings had increased significantly from $28.2 billion for 2005 to $40.2 billion for 2012-a gain of over 140 per cent.3 36