Trump Tariffs, and Buffett on Dividends Vs Retained Earnings
Personal finance, investment philosophies and fun facts - all without the jargon.
Welcome to the seventeenth edition of the Bodhi Newsletter! In today’s edition, we cover:
Trump Tariffs: Panic and Paralysis
Buffet on Dividends Vs Retained Earnings
Trump Tariffs: Panic and Paralysis
By Shagun Khetan
“THIS IS A GREAT TIME TO BUY!!!”, said Trump’s post just a few hours before he announced a 90-day pause on most of his new tariffs(except China). This news sent the S&P 500 up 9.5% for the day. Great news for someone who took the President’s advice and made a decent profit. (Is this even legal!?)
On April 2, 2025, Trump declared a 10% tariff on all imports, effective on April 5, with additional country-specific tariffs set to commence on April 9.
This announcement sent shockwaves through the global economy, while Trump justified the imposition of reciprocal tariffs, ‘Our country and its taxpayers have been ripped off for more than 50 years. But it’s not going to happen anymore.’
Let’s briefly step back and understand what tariffs mean for global trade.
What are tariffs, and what is their impact?
A tariff is a tax imposed by a country on products imported from other countries. Tariffs are usually paid by companies that import goods from abroad. For example, if Walmart imports a $100 shoe from Vietnam, which faces a 46% tariff, Walmart owes $46 to the US Government. Now, Walmart can do 3 things: absorb the cost itself(and hurt their profit margins), force it on Vietnamese shoe manufacturers or pass it on to the consumers; or do some combination of these 3.
The president’s stance on imposing reciprocal tariffs is that American trade deficits(US imports – US exports) with other countries are bad and that America has long been ‘ripped off’ or ‘subsidising’ other countries. According to him, he wants to force tariffs so high that it forces companies to shift production to the US. This, in turn, he says, will increase employment and push up wages. The revenue from tariffs can be used for tax cuts, he said.
Economists have been contesting his arguments, saying tariffs cannot simultaneously achieve all of the stated goals. The same tariffs that are supposed to boost US manufacturing are hurting US manufacturers by disrupting supply chains and raising the cost of their raw materials. There is no reason why extra tariffs could eliminate the trade deficit, as that arises when Americans choose to save less than their country invests. Consumers will pay more and have fewer choices. It’s long been known in economics that tariffs act as barriers to trade, decrease foreign competition and make domestic companies less productive. As stock markets fumbled, shares in Nike, which has factories in Vietnam, fell by 7%. Does America prosper only when Americans sew their own running shoes? Mr. Trump might believe that. Studies show that the calculation of tariffs charged to the US was done in a very rudimentary manner. The document sent by the White House displays a little complex formula for calculating tariff rates:
where xi = total exports to the country, mi = total imports from the country, ε = price elasticity of import demand(set at 4) and φ = elasticity of import prices with respect to tariffs(set at 0.25). Except that ε* φ = 1, and it doesn’t add anything to the calculation. The formula then just becomes trade deficit as a % of total imports for a particular country. Such a reductionist approach to calculate tariffs charged to the US is not just embarrassing for the administration, it also portrays a negative image for other countries when they show tariff rates that are, in reality, not true. These rates were then simply halved and set as reciprocal tariffs.
Earlier in the 20th century, after the stock market crash of 1929, the Smoot-Hawley Tariff Act of 1930 was enacted in an attempt to protect US businesses. Instead, the tariffs did not work, and the US sank deeper into the Great Depression.
Now that we have a decent understanding of the impact of tariffs, let’s get back to the timeline. After the announcement of reciprocal tariffs, a lot of countries approached the US to negotiate bilateral trade agreements. Some countries fought back.
How did trading partners respond?
China’s Finance Ministry announced a 34% tariff on imports from the United States, matching Mr. Trump’s plans for 34% tariffs on exports from China. The Chinese Ministry of Commerce also barred a group of 11 American companies from doing business in China. Mr. Trump threatened to counter Beijing’s retaliatory tariffs with an additional 50% tariff on China. Those tariffs would be additive, meaning that China could face 104% taxes on all exports. China responded with an additional 50% tariff on U.S. goods, meaning all American goods shipped to China faced an additional 84% import tax. Amidst the deepening trade war, Singapore’s PM(faced with the baseline 10% tariffs) highlighted the danger of increasing protectionist trade policies throughout the world, with the US abandoning the free market values it stood for a long time until recently.
To demonstrate the degree of volatility in the current market, consider the havoc that ran through the market on Apr 7:
At 10:10 am ET, rumours spread that the White House was considering a 90-day tariff suspension. In the next 8 minutes, the S&P 500 added $3 trillion in market capitalisation. At 10:34 am ET, the White House officially called the tariff pause headlines ‘fake’. By 10:40 am ET, the S&P 500 erased -$2.5 trillion of market cap from its high, 22 minutes prior.
Now, back to the headline:
The economic turmoil, particularly a rapid rise in government bond yields, caused Mr. Trump to blink on Wednesday afternoon and pause his “reciprocal” tariffs for most countries for the next 90 days, according to four people with direct knowledge of the president’s decision. China would not be included in that pause, he said. Instead, he raised tariffs on its exports to 125% after Beijing announced a new round of retaliation, in addition to the 20% tariffs, bringing the total tariffs on China imposed by the Trump administration to 145%. Judging by Mr Trump’s on-again, off-again approach to tariffs on Canada and Mexico, there is reason to think he will revive his threat of higher tariffs before the 90 days are up. ‘Make America Great Again’, what greatness means in the US for Mr. President remains to be seen.
What about India?
Given such a painful trade war with China, export flows could shift to emerging economies like India and Brazil. Companies like Apple are hoping to shift production to India as soon as possible, which might give a boost to India’s GDP. Jaishankar emphasized that India’s strategy has been focused on constructive engagement with the Trump administration, with the goal of reaching a bilateral trade agreement. “To the best of my knowledge, and I could be corrected here, I think we are the only country after President Trump has resumed the presidency the second time, which has actually reached such an understanding in principle,” Jaishankar added.
Buffet on Dividends Vs Retained Earnings
By Soham Dengra
In my last article, we looked at how Buffet carefully distinguished between risk and volatility, explaining how the two are very different and should not be confused. In today’s article, we look at Buffett’s approach and view on- Dividends vs Retained Earnings.
For a highly profitable company like Berkshire, the excess cash which it generates can essentially be deployed in 3 main ways (in decreasing order of importance)-
Reinvestments- Reinvesting money back into the business to expand operations or widen its existing moats.
Acquisitions- If the company still has cash left over after reinvestments, the company should try searching for companies which it can acquire.
Stock Repurchases- Stock buybacks, which are done when the company’s stock price is trading below its intrinsic value, are the surest way to increase shareholder value, as it is- in Buffett’s words- essentially equivalent to buying a $1 bill for a lesser amount.
However, it must be noted that Buffett doesn't mention dividends as one of the methods of capital allocation for such firms. To explain why retaining earnings would be better than paying out dividends, he uses the following example:
Assume you and I own 50% each of a business with $2 million of equity. The business earns a ROE, i.e. return on equity of 12%, translating to $240,000 annually. Additionally, outsiders will happily buy our share of the business at a premium of 125% of its equity value. Thus, each of our 50% stakes is worth not $1 million but $1.25 million.
Scenario 1:
In the first scenario, we reinvest 2/3rd of the firm’s earnings back into the business and take out the other 1/3rd as dividends. Therefore, out of the $240,000 that the business will earn, we will pay out $80,000 and retain $160,000 of earnings to grow our business.
Thus, each of us would receive $40,000 dollars as dividends in the first year, and as our business’ earnings grew, so would our dividends. Annually, our dividends and stock price would go up by 8% each year (12% ROE - 4% dividends).
In this case, after 10 years of running this fantastic business, the company would have a net worth of $4,317,850 ($2 million compounded at 8% per year), and we would receive $86,357 ($40,000 compounded at 8% per year) each in dividends.
Furthermore, each of our stakes in the company would now have a value of $2,698,656 (125% of the current book value).
Scenario 2:
However, there is a second scenario Buffett calls the “sell-off approach”. In this case, we would retain all earnings in the company, paying out nothing as dividends. Instead, to meet our expenses, we would just sell 3.2% of our share in the company annually. In year 1, this approach would give us $40,000 worth of cash as we sell 3.2% of shares at 125% book value, i.e. 3.2% of $1,250,000.
In this “sell-off” approach, our company’s net worth increases to $6,211,696 at the end of 10 years ($ 2 million compounded at 12% per year). As we are selling 3.2% of our shares each year, our percentage ownership of the company is now lower at 36.12% instead of 50% in the first case. However, as the business has compounded earnings at a much faster rate (12% vs 8%) in this case, our share of the company’s net worth would be $2,243,540. Further, since we can sell each dollar of equity in this business at $1.25, the market value of our shares would be $2,804,425- which is 4% greater than the value we achieved in the dividend payout approach.
What does this mean?
This exercise shows us that if a company decides to reinvest all its earnings instead of paying out a dividend, it leaves its shareholders significantly wealthier in the long run. This “sell-off” approach results in an overall reduced % of holding in the company, however, because of the reinvestment, the business- and subsequently its per-share earnings- grows at a much faster pace, and thus the value of each share increases significantly enough to leave the investor richer compared to the scenario where a dividend was paid.
Moreover, other than the disadvantages explained above, the dividend payout approach has 2 further issues-
1. It imposes a uniform % of payout on ALL shareholders- If the company pays out 40% of earnings as dividends, then those who wish for a 30% or 50% payout have to forcibly accept a 40% payout against their wishes.
2. The tax consequences- The entire dividend amount received by the investors is taxed (even in India, dividends are taxed according to your income tax slab), compared to the sell-off program where only the capital gains on the stock sales are taxed.