Terry Smith: The Ideal Company Doesn’t Pay A Dividend

In his latest interview with Fund Insiders Forum De Tijd & L’Echo, Terry Smith discusses a number of topics including why the ideal company to invest in doesn’t pay a dividend. Here’s an excerpt from the interview:

Question: How important is this dividend yield for you and your selection of the companies?

Smith: Not at all important to us. You in my view you should never invest in equities for income. You should invest in equities for the greatest total return that you can get. So that’s the growth of the share price plus any income and if you need to spend some money sell some of your holdings, which I know isn’t rational to some people but I assure you is the correct way to do this.

The ideal company doesn’t pay a dividend and if a company can make a 30% return on capital why would you want it to pay you a dividend? You by and large can’t make a 30% return on capital so you want it to retain the earnings and generate that return for you.

That’s something which I touched upon in the presentation, this unique facet of equities that they’ve got this unique characteristic of retaining part of your earnings for you and reinvesting it. If they do that in a high quality business with higher returns on capital they will compound in value much better than you can with a dividend that they pay you.

People say well you could always take the dividend and reinvest it, yes after you’ve paid the tax primarily I mean I know you might have it in a non-taxable account but aside from that you’re basically… it’s an inefficient mechanism. There are dealing costs and tax to take into account

I guess the thing that seals it more than anything for this is Berkshire Hathaway, the famous… infamous Warren Buffett’s company which he took control of in June I think was in 1965 and which at least until recent years, very recent years, was probably the greatest investment performance post World War II in terms of its performance has never paid a dividend.

You can watch the entire interview here: