Wednesday, August 20, 2014

How to Invest Like Warren Buffett

Warren Buffett is the most successful stock investor in the world. He made his first $20 million dollars by running a hedge-fund like investment partnership in the 1950’s and 1960’s. However, if he hadn’t changed his investing habits from being a pure value investor to being influenced by Charlie Munger and Phillip Fisher, he would not have been as successful as he is today. Buffett’s earlier cigar-butt investments produced large gains initially, but then he had to do more research in order to find more value investments, and reinvest his money. What he learned from See’s Candies, Berkshire’s Insurance Operations and Newspapers however, shaped the way Buffett invests. By using his investing acumen to identify these superb businesses, his company managed to earn a recurring stream of profits for years to come.

The best lesson that Warren learned happened when he purchased See’s Candies for 25 million dollars in the 1970’s. The business had a strong brand, which was synonymous with quality, and had a loyal customer base. The strong competitive advantages of the business helped it maintain pricing power, and slowly boost prices to consumers over time. When competitors tried to emulate its packaging in order to steal market share, they were sued by See’s and promptly had to stop doing that. At the same time the business did not need to reinvest a substantial portion of earnings in order to increase sales over time. As a result, the business has generated over a billion dollars for the forty years that Berkshire Hathaway (BRK.B) has owned it. In effect, the business has paid for itself almost 50 times over.

The other businesses that Buffett purchased included newspaper and insurance companies. At the time, newspapers had strong competitive advantages in metropolitan areas, which allowed them to serve as the only local exchange of information, services and goods in a given city. All of these businesses were flush with cash, and were spitting excess free cash flows every quarter. They also had strong competitive advantages, and didn’t need all of their profits to be reinvested back in the business in order for it to grow. Unlike the cigar-butt investments that Buffett made earlier in his career, the companies with competitive advantages managed to deliver returns for years to come, rather than deliver a one-time return and then nothing.

Buffett then used the free cash flows from these businesses to purchase more income streams that generated more excess cash flows. This is very similar to what dividend investors in the accumulation phase are doing. They design a dividend portfolio, and then use dividends received in order to purchase more shares of other attractively valued companies. As a result, I have long argued that Buffett is a closet dividend investor. If you read his letters to shareholders closely, one would notice that he keeps reiterating how Berkshire Hathaway’s investments keep producing excess cashflows of staggering amounts every month.

In fact, dividend investors can essentially emulate Buffett’s style by creating their own mini-Berkshire’s using dividend growth stocks purchased at attractive valuations. Some of the most widely-held dividend stocks to serve this purpose include:

McDonald’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has increased dividends for 38 years in a row. The company has a 10 year average dividend growth rate of 22.80%/annum. Currently, the stock is selling for 17 times forward earnings and yields 3.20%. Check my analysis of McDonald's.

Wal-Mart Stores Inc. (WMT) operates retail stores in various formats worldwide. This dividend champion has increased dividends for 41 years in a row. The company has a 10 year average dividend growth rate of 18%/annum. Currently, the stock is selling for 14.80 times forward earnings and yields 2.50%. Check my analysis of Wal-Mart Stores.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend stock has increased dividends for 6 years in a row. The company has a five year average dividend growth rate of 14%/annum. Currently, the stock is selling for 16.50 times forward earnings and yields 4.10%. Check my analysis of PMI.

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. This dividend achiever has increased dividends for 19 years in a row. The company has a 10 year average dividend growth rate of 19.40%/annum. Currently, the stock is selling for 10.60 times forward earnings and yields 2.40%. Check my analysis of IBM.

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has increased dividends for 32 years in a row. The company has a 10 year average dividend growth rate of 9.60%/annum. Currently, the stock is selling for 12.80 times forward earnings and yields 2.70%. Check my analysis of Exxon Mobil.

Full Disclosure: Long MCD, KO, WMT, PM, IBM and 1 share of BRK.B

Relevant Articles:

What Attracted Warren Buffett to IBM?
Warren Buffett is now working for me
Why Warren Buffett purchased Exxon Mobil stock?
Warren Buffett Investing Resource Page
How Warren Buffett built his fortune

10 comments:

  1. Great article I am doing just that but not with NYMT or MO because I have over a 15% dividend with these stocks and I don't want to mess that up. Suzanne

    ReplyDelete
  2. Do you know of any FREE charts that show historic dividend yields of individual stocks? Ycharts charges. I ran across one website that was actually what I was looking for and then stupidly forgot to bookmark it.

    ReplyDelete
    Replies
    1. I am not aware. However, nothing stops you from developing your own database for tracking this stuff. I would personally never pay for a program that allows me to chart data, which is widely available online. But, I am the type of person who sees each dollar I spend today as $100 I would have in 50 years. The only investment costs I barely tolerate are commissions and taxes. The more you spend on investments, the less you get to keep.

      Delete
  3. DGI,

    Great stuff. I'm with you on creating a mini Berkshire. The dividends roll in and I get to allocate that capital as I see fit. However, I'm certainly not working with "elephant guns" like Uncle Warren. But my peashooter still gets the job done for me.

    I see you didn't list IBM on your disclosure. Are you no longer invested?

    Best wishes!

    ReplyDelete
    Replies
    1. Hi DM,

      Oh, I own IBM. I also own BRK.B. Updated disclosure.

      Thanks for stopping by!

      Delete
  4. Hi DGI,
    Great post! I always love to hear a little history on the great Warren Buffett. All of those are fantastic stocks to add to any dividend growth portfolio.

    I really enjoy reading your stock analysis. Thank you for all the hard work!

    Cheers!

    ReplyDelete
  5. Nice article. I wouldn't call IBM and PM dividend champions. They still have some way to go.

    ReplyDelete
  6. Some brokers have yield charts. I use TD/Thinkorswim for $5 trades and they have 20yrs of yield or PE charts if you want.

    ReplyDelete
  7. So dividends are basically a type of float then?

    ReplyDelete
  8. We can try to create a mini Berkshire but let's not forget Buffet borrows from the float of his insurance businesses and then goes and buys stocks and companies with it. I believe he's enjoyed the equivalent of roughly 150-200% margin without the interest expense and margin calls. Tough for an individual investor to duplicate.

    ReplyDelete

Questions or comments? You can reach out to me at my website address name at gmail dot com.

Popular Posts