How Warren Buffett made his fortune

Most investors are familiar with Warren Buffet, who is the man in command at Berkshire Hathaway (BRK.B). Buffett is one of the most successful investors of all time, with a net worth placing him somewhere in the top three richest people in the world. His partner in crime was Charlie Munger, who has worked with him for the past 50 years. While most investors are familiar with the story of Berkshire Hathaway, few seem to know how exactly Buffett made his first millions, that catapulted him to Berkshire Hathaway and the companies and stocks he owns through it.

Buffett started several investment partnerships in 1956 with approximately $105,000 in investor money, after his former employer Graham-Newmann investment partnership was liquidated. Buffett had put an initial $700 of his own money, which ballooned to a stake worth $20 million by the time he liquidated his investment partnership in 1969. The assets under managed had grown to $100 million by that time. The Berkshire Hathaway (BRK.A) annual letters to investors have been inspired by Buffett’s annual and semi-annual letters to his limited partners.

Per the Buffett Partners agreement, Buffett as the General Partner received a cut of the profits. For every percentage point gain above 6% in a given year, Buffett collected 25% of the gains. The Buffett Partnership Limited (BPL) was essentially a hedge fund, which pooled investor’s money and invested them at the discretion of the fund manager. Buffett never had a losing year during the thirteen years he ran the partnership, and he also managed to add new investors along the way. In addition, he reinvested any gains he made as a general partner back into the partnership.

Buffett invested in the following types of companies at the partnership: generally undervalued securities, work-outs and control situations. Work-outs included stocks whose financial results depend on corporate actions rather than supply and demand factors created by buyers and sellers. Control situations include occasions where BPL either controlled the company or took a sufficiently large position that allowed it to influence policies of the company.

After the BPL was liquidated, Buffett received shares in Berkshire Hathaway, as well as shares in companies which ultimately merged in Berkshire. And the rest is history.

The lesson to be learned from this exercise is that in order to become rich, Warren Buffett had a scalable business model, with a substantial amount of leverage. Unfortunately, BPL was mostly a one-man operation, although the turnaround expert he employed with Dempster Mill Manufacturing company is a rare situation where he employed others. He did exchange ideas with several of his value investing friends however. Buffett’s investment model worked well when he had $100,000 in the partnership, as well as during the time that he had $100 million. The overvalued market in the late 1960’s however presented a change to his investment strategy. Buffett had leverage to make a lot of money, simply by being the general partner and earning a good cut on any earnings that the partnership generated, without much downside for himself. On the other hand, Charlie Munger made his initial million by using debt leverage to invest and build real estate.

The true genius of Buffett is his complete transformation in the 1970’s, when he started purchasing stock in companies with strong competitive advantages. He essentially held those stocks as long-term investments, and in the event where Berkshire acquired entire businesses, he delegated the whole oversight of day to day operations to skilled management. The companies he invested in the 1950’s and 1960’s represented mostly investments that were one-time producers of substantial gains for BPL. It took Buffett a lot of time to uncover those opportunities, but once they reached full valuation and he sold them, they were no longer producing any benefit for his partnership. He then had to spend more time to find more investments to allocate the now higher cash hoard. However, the companies and securities that Buffett purchased since the 1970’s for Berkshire Hathaway generate recurring cash flow streams to the company. As a result, the effort required to uncover these hidden gems resulted in cash distributions paid to the main holding company for decades. He then used these cash streams to purchase even more cash flow generating assets, which is why I believe that he is a closet dividend investor.

The genius of Buffett is that he has been able to uncover undervalued assets, over many different asset classes. Examples include his purchase of silver (SLV) in 1998, real estate investment trusts in 1999, foreign currencies such as the Euro in the early 2000's as well as selling long-dated puts on major market indices. While he has a strategy of always looking for undervalued assets, he has been able to make a fortune for Berkshire by being flexible, and avoiding following a "rigid" strategy. By training himself to spot opportunities when they arose, he has been able to constantly reinvent himself and make money in different environments.

Full Disclosure: None

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This article was included in the Carnival of Wealth

Should you invest in Wells Fargo (WFC)?

In order to identify attractively valued dividend stocks, I follow a monthly screening process, where I go through the list of dividend champions and dividend achievers to look for bargains. In addition, I often stumble upon quality income stocks during my review of the dividend raises for the week or on an ad hoc basis through interactions with other dividend investors.

Some investors that I know have been purchasing Wells Fargo (WFC), which is one of the best run large banks in the country. The most prominent buyer of Wells Fargo is Warren Buffett, who has been accumulating the stock for the past four – five years in his personal portfolio and for Berkshire Hathaway (BRK.B). Buffett finds that the key competitive advantage for Wells Fargo is its low cost of funds. The bank took out 25 billion from TARP, and as a result had to slash its dividend and acquire Wachovia.

I had heard only great things about Wells Fargo, which increased my interest in the bank. As a result, I took a look at the financials over the past years.

The financial included Wachovia since 2009. The thing that I noticed was that there was no growth over past four years in revenues. The amounts from non-interest fees have held steady, while the net interest revenues have decreased slightly. Since 2009 however, expenses have decreased from $70.688 billion all the way to $57.615 billion in 2012. The main driver behind the decrease in expenses was due to decrease in the Provision for credit losses from $21.668 billion in 2009 all the way to $7.217 billion in 2012.

At the same time earnings per share increased from $1.75 in 2009 to $3.36 in 2012, while annual dividends increased from 49 cents/share to 88 cents/share. The forward annual dividend payment is $1.20/share. Wells Fargo also increased the number of shares each year since 2009 to 5.351 billion. Since the main reason behind growth has been the reduction in the Provision for credit losses, it seems that future growth would be limited, unless the company either earned more from loans or more from fees.

Actually, net interest income has been declining, while the amount of loans has been slightly up from $783 billion in 2009 to $800 billion in 2012. Securities available for sale have increased dramatically however to $235 billion, up from $173 billion in 2009. At the same time, deposits have increased from $781 billion to $946 billion. The main problem behind lending these days is that it is much tougher to loan money, and interest rates are dropping at the loan rate level. At the deposit rate level, interest rates are essentially zero. As a result, in order to compensate for the decrease in the net interest rate margins, Wells Fargo would have to ramp up its lending. With interest rates projected to be low for the next three years, increasing lending will be the only way out to profit growth in this segment, without sacrificing credit quality however.

The issue with ramping up credit right now however is that when interest rates go up in five - seven years, Wells Fargo might end up owning assets such as 30 year loans at 4% ( I made this number up), when its cost of capital is close to or above 4%.

The mitigating factor however is that the average maturity of loans is under 30 years, and also a portion of Wells Fargo’s loans are floating rate. The company will have almost $300 billion in loans mature within the next five years. Over half of these loans were floating rate ones. New loans will generate more income however.

I like the fact that the company also has a substantial amount of non interest based revenues, which account for half of Wells Fargo’s revenues. Total trust and investment fees and total mortgage activities accounted for over half of those non-interest revenues. The portion of fee income is approximately 59%, with the rest derived from mortgage origination, other, insurance and gains from trading. It is good to hear that the company is able to generate diverse income streams to fall back on. The company is able to cross-sell products to customers who enjoy their banking relationship with it.

One positive could be that the company has a record $945 billion in deposits, and has attracted over $200 billion since 2008. While not all of the funds are allocated to loans, this could be a good indicator going forward, because it means more banking relationships over time. A customer can open a checking account today, then decide to take a mortgage, open a brokerage account or do other business with Wells Fargo. The customer relationship piece is an intangible part of the business, but nevertheless could yield dividends down the road. In addition, with record low interest rates, these deposits are almost not costing anything to Wells Fargo.

Overall I like the fact that Wells Fargo is trading at 10.80 times earnings, yields over 3% and has a sustainable dividend payment. The company has a solid asset base, which will pay dividends for years. However, I am not certain where future growth will come from. The increase in the company’s profit since 2009 has been mostly due to the reduction in the provision for loan losses. At the same time revenues have been flat. Unfortunately, a company cannot grow shareholder value without growing revenues. You can only cut so much expenses. If Wells Fargo were to start loaning out more funds, it would possibly translate into more revenue, as long as borrower quality is maintained and the net interest margin does not drop from here. There is a margin of safety in today’s valuation, but until I can see revenues increasing, I am going to sit this one out on the sidelines.

At the same time, I am a big fan of the five largest Canadian banks. These companies have a dominant position in the Canadian market, and earn very good amount of fees from customers. At the same time they have been able to grow interest and non-interest income, increase number of branches and expand by buying US bank assets. Back in early 2013 I purchased shares in Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Royal Bank of Canada (RY), Toronto-Dominion Bank (TD), Canadian Imperial Bank of Commerce (CM).

Of course, if Canada’s housing market softens, these big five banks would likely perform worse than the likes of Wells Fargo. The table above shows the Net Interest and Non Interest Income trends for Toronto - Dominion Bank (TD). It also shows the trends in the provision for credit losses as well. Canada adopted IFRS accounting standards recently, which is why information for prior to 2011 is under Canadian GAAP. Either way however, the trend in the three pieces of information would be similar under both accounting methods. The trend over the past few years in both interest and non-interest income for the big five Canadian banks is positive. They have been expanding domestically and internationally, which makes seeing where growth will come much easier.

Full Disclosure: Long BMO, BNS, RY, TD, CM

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Warren Buffett on Dividends: Ideas from his 2013 Letters to Shareholders

Yesterday, Berkshire Hathaway’s (BRK.B) 2013 letter to shareholders was posted on the company’s website. As a long-term follower of Warren Buffett, I voraciously read through every single word of it. I was particularly excited that Buffett spoke about dividends and dividend paying stocks on several occasions in the letter. His standing on paying dividends have always perplexed investors in Berkshire. In fact, I have even referred to him as a closet dividend investor before.  In this article, I am going to post my thoughts on the letter.

At the very bottom of the letter, Warren Buffett discusses why it makes sense for Berkshire Hathaway to continue not paying dividends. In essence, he comes to the conclusion that reinvesting all profits at above average returns will serve shareholders better in the long run, than paying dividends. This reinvestment of capital refers to either direct reinvestment back into the business that generated them or by purchasing new businesses that generate high returns on equity. This sounds like a reasonable idea, and is one that Buffett has been very successful at since the mid 1960’s. One of Buffett’s arguments against paying distributions was that investors, who require income, can easily afford to sell a portion of their shares every year. In his theoretical example, all earnings were reinvested at a constant rate of return, and the stock price always traded at a premium to book value. The main issue I had with his thinking was that in the real world, things are not linear at all. Stock prices fluctuate wildly above and below book values, and reinvested rates of returns are often equally volatile.

Overall, Warren Buffett is not interested in distributing profits to shareholders in the form of dividends, because he believes that he would be much better at allocating cash than ordinary shareholders. While plowing all of realized earnings back into the business or in new ventures comes with its own sets of risks and limitations, Buffett has proven his uncanny ability to reinvest successfully. He is after all, the Oracle of Omaha, and the most successful US investor. Unfortunately, he is in his 80s, and is close to retirement. As a result, given the massive scale of Berkshire today, the success of future acquisitions might not lead to similar extraordinary performance. In addition, although keeping all earnings into Berkshire might have worked for Buffett and his followers, there are only a handful of companies which have managed to do the same, and be successful at it.  In your typical US Corporation, the overpaid management is greedy for acquisitions and empire building at all costs, since they have very little if any actual stake in the business. Expanding your business is often subject to limitations, as I explained in an earlier article.

In essence, Buffett’s Berkshire is acquiring businesses, shares in businesses with its excess cashflows that didn't need to be invested in its existing subsidiaries. In a previous article I have argued that dividend investors can similarly create their own mini-Berkshire style portfolios, by investing in dividend paying stocks, and reinvesting distributions into attractively-priced shares. Incidentally, the largest four portfolio investments include Wells Fargo (WFC), IBM (IBM), Coca-Cola (KO) and American Express (AXP), all of which pay dividends. In the case of Coca- Cola and IBM, we have companies that have raised them for years if not decades. These businesses and shares generate additional cashflows that need to be reinvested. In his letter he said the following:

“Most companies pay consistent dividends, generally trying to increase them annually and cutting them very reluctantly. Our “Big Four” portfolio companies follow this sensible and understandable approach and, in certain cases, also repurchase shares quite aggressively.

We applaud their actions and hope they continue on their present paths. We like increased dividends, and we love repurchases at appropriate prices.”


Buffett focuses on businesses with the potential to generate growing cashflows over time with limited needs for investment, and then utilizes his experience as a capital allocator to reinvest profits into more income generating assets.

Full Disclosure: Long KO

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What does Buffett see in Heinz (HNZ)?

H. J. Heinz Company (HNZ), together with its subsidiaries, manufactures and markets food products for consumers, and foodservice and institutional customers in North America, Europe, the Asia Pacific, and internationally. The company had consistently boosted dividends since 2003. Over the past week, Heinz agreed to be acquired by Berkshire Hathaway and a private equity firm 3G Capital for $72.50/share. The size of this acquisition fits the elephant category that Buffett often describes in his annual letters to shareholders. In a previous article, I discussed why Buffett likes dividend stocks. This is another dividend growth stock, that attracted Buffett's attention. So what makes this company an interesting bet?

Warren Buffett, Chairman and CEO of Berkshire Hathaway said, “Heinz has strong, sustainable growth potential based on high quality standards, continuous innovation, excellent management and great tasting products. Their global success is a testament to the power of investing behind strong brand equities and the strength of their management team and processes. We are very pleased to be a part of this partnership.”

First of all, the company carries a strong brand name. Everywhere you go out to eat in North America, you can find Heinz ketchup. Consumers are aware of the brand, and are trained from very young age into being repeat customers, without even realizing it. As a result, the company has pricing power to pass on cost increases to customers.

Second, the company is being purchased at a decent valuation. Based on the expected EPS for 2013 of $3.54/share, the acquisition price is equal to 20.50 times earnings. Analysts are forecasting $3.79/share in 2014 earnings and a 6.60% annual growth over the next five years. The company is also paying $2.06/share in annual dividends, which would have likely increased, had it stayed public . Berkshire is expected to finance the deal with $12.12 billion, with $8 billion being in preferred stock yielding 9%, while the remainder will provide them with equity exposure in Heinz. They will split it with 3G Capital Partners.

Third, the business has room to grow internationally. Heinz has a 59% market share in the US ketchup market, while only a 26% internationally. With the “westernization” of emerging markets, and the rise in the middle class, Heinz will probably gain more prominence, which would result in higher sales and profits. Furthermore, the company also owns other strong brands such as Weight Watchers, Smart Ones and Ore-Ida.

Dividend stocks make great acquisitions. These slow and steady businesses with dependable growing cashflows are perfect for investors that own 1 share to 100% of the shares. In the case of Heinz, the company is trading at 20 times earnings today. However, it will likely grow at a steady rate, and deliver great dividends to owners for decades to come, as it has for decades before. The firm has paid dividends since 1911, and has raised them since 2003. Before that, it had raised dividends for almost 39 years in a row, but cut them at the end of 2002. Given the strong momentum in earnings, investors would have enjoyed much better long-term returns going forward. I have no doubt in my mind that Heinz would have managed to become a dividend achiever at the end of this year.

Full Disclosure: None

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Warren Buffett’s Dividend Stock Strategy

Warren Buffett is without doubt the best investor the world has ever seen. Starting with a few hundred dollars in 1956, he managed to transform his stake to $20 million by the time he liquidated Buffett Partnership Limited in 1969. His entire net worth by then was in Berkshire Hathaway (BRK.B) stock, a small textile mill which he transformed into a diversified holding company.

After reading his letters to shareholders, and analyzing SEC filings, I have uncovered an interesting trend in his long-term investments at Berkshire. Notably, Buffett has focused on companies which tend to grow income without much in additional capital investment. This is possible when you invest in a business that has strong pricing power, because consumers are addicted to the brand name product or because you have some other form of strong competitive advantage. The 1972 purchase of See’s Candies is a prime example of this. In his 2007 Letter to Shareholders, Buffett mentioned the following:

We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million.

Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses.

It is evident that he invests in businesses with minimal capital needs, and utilizes the profits to purchase other businesses. This is similar to what a dividend investor typically does – accumulate distributions and then invest them in the best long-term opportunities at the time. In essence, the 1972 investment in See’s Candies is producing mind-boggling yields on cost currently. Warren’s investments in Washington Post (WPO), Coca-Cola (KO) and American Express (AXP) have also resulted in double or even triple digit yields on cost.

In 1973, Buffett initiated a position in Washington Post (WPO) for $10,628 million. His shares have an effective cost basis of $6.15/share. At the annual dividend of $9.80/share, his company’s yield on cost is 159%.

Between 1991 and 1994 Buffett acquired over 151,670,700 million shares of American Express (AXP) at a cost of $1.287 billion, which translates into $7.96/share. His initial investment was using preferred shares that were convertible into ordinary shares at a fixed price, plus additions to his holdings. At the present annual dividend of 80cetns/share, his yield on cost is exceeding 10%.

Between 1988 and 1994, Berkshire Hathaway accumulated 400 million split-adjusted shares of Coca-Cola (KO), for $1.30 billion dollars. His average cost per share comes out to approximately $3.25. Based on the annual dividend of $1.02/share, Berkshire’s yield on cost is a stunning 31.40%/year. This means that simply by accumulating the dividends for three years, Berkshire will recover its investment, but still retain ownership in Coke and have a claim on future distributions. In his 2010 Letter to Shareholders:

Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn't be surprised to see our share of Coke’s annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business.

Unfortunately, as his holding company got bigger and had billions to allocate on a monthly basis, his focus has been mostly on large-cap “elephant” acquisitions. The 2010 acquisition of Burlington Northern is a prime example of this change in strategy.

It is also interesting that most of the businesses that Buffett has purchased such as Geico, Flightsafety International or Wesco Financial had achieved either the dividend achievers or dividend champions status. His purchase of quality, wide-moat companies with growing earnings, has paid huge and rising dividends for Berkshire Hathaway. These seeds have been reinvested in additional businesses, thus expanding cash flow available for investments dramatically. This is a strategy that is similar to the strategy that many dividend growth investors tend to employ. Inspired by Buffett’s legacy, I have been quietly building my own dividend machine, mini Berkshire.

Full Disclosure: Long KO

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Build your own Berkshire with dividend paying stocks

I recently read the book “The Snowball” by Alice Schroeder. I have been a great follower of anything on Buffett for years, and this book definitely provided additional insight in the way the world’s richest investor thinking process.

I have long advocated the idea that Buffett is a closet dividend growth investor. After all, the perfect companies that he typically tries to invests in share the following characteristics:

1) Strong Competitive Advantages, Wide Moats, Strong Brand Names

2) A loyal customer group, willing to pay up for the product/service

3) High Returns on equity

4) Generating excess cashflow

5) Minimal capital requirements

One such perfect business that Buffett was able to purchase in 1972 was See’s Candy. The company was purchased for $25 million, when sales were $30 million, operating profits $5 million and the capital required to operate the business was $8 million. The company was selling 16 million pounds of chocolate in 1972.

Fast forward 35 years, and See's Candy was selling 31 million pounds of chocolate in 2007. This represented a 2% annual growth in sales. Sales were $383 million, while pre-tax profits were $82 million. While the required capital to run the business had increased to $40 million, the business had been able to generate $1.35 billion in pre-tax earnings. In essence, almost $1.30 billion in pre-tax profits were the excess cash flow, which were distributed to Berkshire for Warren to manage.

In fact, this strategy of purchasing businesses which generate cash flows in excess of the business reinvestment requirements, are actively sought after by Buffett. One needs to look no further than the stock portfolio which the Oracle of Omaha manages. Some of the largest holdings include strong dividend stocks such as Coca-Cola (KO), Johnson & Johnson (JNJ), Procter & Gamble (PG) and Wal-Mart (WMT) to name a few. All of these cash machines have been able to generate sufficient earnings to raise distributions to shareholders for several decades in a row. This cash is then used by Buffett to purchase more stocks or more businesses.

In essence, this strategy is similar to what dividend growth investors like to do. By creating a diversified portfolio of world class blue chip dividend paying stocks, investors are essentially creating a cash machine that would throw off enough cash to buy more shares in quality companies or to provide for in retirement.

The building blocks of a successful dividend machine could include companies like:

Johnson & Johnson (JNJ) engages in the research, development, manufacture, and sale of various products in the health care field worldwide. This dividend aristocrat has managed to raise dividends for 50 years in a row. Yield: 3.80% (analysis)

The Procter & Gamble Company (PG) provides consumer packaged goods in the United States and internationally.This dividend king has raised distributions for 56 years in a row. Yield: 3.40% (analysis)

McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants primarily in the United States, Europe, the Asia Pacific, the Middle East, and Africa. This dividend aristocrat has raised distributions for 35 years in a row. Yield: 2.90% (analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. This dividend aristocrat, has rewarded shareholders with a dividend hike for 38 years in a row. Yield: 2.70% (analysis)

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend achiever has hiked distributions for 25 years in a row. Yield: 3.40% (analysis)

PepsiCo, Inc. (PEP) engages in the manufacture and sale of snacks, carbonated and non-carbonated beverages, dairy products, and other foods worldwide. This dividend aristocrat has raised distributions for 40 years in a row, and currently has a better valuation than arch rival Coca-Cola (KO). Yield: 3.10%(analysis)

For more lists of quality dividend stocks, which should be core holdings a in dividend portfolio, check this list.

Full Disclosure: Long JNJ, PG, MCD, WMT, CVX, KO, PEP

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Should you follow Buffett’s latest investments?

Warren Buffett is one of the most successful investors of all time. He has been able to transform a small textile company into a $200 billion conglomerate, with interests in insurance, manufacturing, utilities and railroads. One of the most followed segment of the business however is the investment portfolio. In a previous article, I discussed how investors who closely followed Buffett’s moves in the Berkshire Hathaway (BRK.B) stock portfolio between 1976 and 2006 would have significantly outperformed the market.

The company is required by the SEC to publicly disclose its stock holdings each quarter. Sometimes, Buffett is able to request an exception for holdings he is in the process of accumulating. This is to ensure that investors who closely follow his trades do not bid up the prices of stocks he is purchasing, while he is building up his positions.

Over the past week, Berkshire Hathaway disclosed new holdings in International Business Machines (IBM), Visa (V) and Direct TV (DTV), Intel (INTC), CVS Caremark (CVS) and General Dynamics (GD). I have long speculated that Buffett is a closet dividend investor. Indeed, Berkshire’s portfolio generates over $1.40 billion in annual dividend income. Most of the new additions represent stocks which could easily be characterized as dividend growth companies. I have analyzed each one below, in order to determine if they are decent buys at the moment.

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. Big Blue has paid dividends for 100 years, and raised them for each of the past 16 years. The company has been able to transform itself from a hardware company to service and consulting juggernaut. I would consider initiating a position in IBM on dips below $150. The major issue with IBM is the low yield of 1.70%. (analysis)

Intel Corporation (INTC) engages in the design, manufacture, and sale of integrated circuits for computing and communications industries worldwide. The leader in microprocessors has been able to raise distributions for 8 years in a row. I would consider adding the stock to my portfolio in a few years. Yield: 4.10% (analysis)

Visa Inc. (V) operates retail electronic payments network worldwide. It facilitates commerce through the transfer of value and information among financial institutions, merchants, consumers, businesses, and government entities. Since initiating a dividend in 2008, the company has raised it three times. Given its low payout ratio, and expected growth in EPS, Visa has the potential to become the next big dividend growth stock. Yield: 0.70%

General Dynamics Corporation (GD) provides business aviation, combat vehicles, weapons systems and munitions, military and commercial shipbuilding, and communications and information technology products and services worldwide. This dividend achiever has managed to boost distributions for 20 years in a row. Betting on this firm means betting that US will continue engaging in war activity in the future, and that the budget deficits would not decrease the appetite for military equipment. Yield: 3%

CVS Caremark Corporation (CVS) operates as a pharmacy services company in the United States. The company has managed to boost distributions for 8 years in a row. Yield: 1.50%

Overall, I find all of these as great businesses, which fit the Buffett model of having durable competitive advantages, pricing power and strong cash flow generation. Of all, I find Visa has the potential to be a great dividend growth story for the next few decades. Visa and MasterCard (MA) are basically a duopoly, which will certainly benefit from an increasing number of cashless transactions globally. Despite the low current yield, and the fact that the shares are close to being overvalued currently, I found the megatrends powerful enough to initiate a position in the stock. The long term dividend growth and total return potential of a company like Visa is hard to ignore. Thus being said, from a risk management perspective, I will only keep a smaller position in the company.

Full disclosure: Long V

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This article was featured in Carnival of Personal Finance #337

Warren Buffett – A Closet Dividend Investor

Warren Buffett’s latest annual letter to Berkshire Hathaway (BRK.B) shareholders was published on Feb 26. The major theme of this letter was how to value Berkshire Hathaway as a company. Given the diverse nature of the company’s operations, this is no small task. Another important item that the Oracle of Omaha discussed was the dividend stream that flows to Berkshire on a regular basis.

In a previous article I outlined several reasons why Buffett is a dividend investor. While his investment style in the 1950s – 1970s was simply to purchase stocks trading at a discount to their fair values, it evolved into purchasing entire businesses or equity stakes in them. The common characteristic of these businesses was that they had strong competitive advantages, high returns on equity and as a result were generating excess cash flows. Buffett then used these excess cashflows to invest in other businesses, thus further compounding his capital base. Another characteristic common for Buffett’s stock investments is that most of them pay a dividend as evidenced by the largest positions for Berkshire Hathaway (BRK.B).

In addition to that Berkshire is expected to earn fat dividends from its investments in preferred stocks in General Electric (GE) and Goldman Sachs (GS) as well.

For the foreign based shares listed above I converted the amount of shares Berkshire Held at Dec 31, 2010 to the respective number of ADRs traded on US exchanges. For any currency translations I used the exchange rate as of Dec 31 as well.

Of particular importance are Buffett’s investments in Coca-Cola (KO), Procter & Gamble (PG) and The Washington Post (WPO), which was not listed above.

Buffett’s cost basis in Coca-Cola (KO) is $1.3 billion. At the current distributions rate he is essentially generating a yield on cost of 29%. This means that every three years he gets his initial investment back in the form of dividends alone. The majority of his position in the company was initiated between 1988 and 1989. Check my analysis of Coca-Cola (KO).

In Buffett’s words “Other companies we hold are likely to increase their dividends as well. Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn’t be surprised to see our share of Coke’s annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business.”

Buffett’s cost basis in Procter & Gamble (PG) is $464 million. He is generating a yield on cost of over 31% for his shareholders on this investment. The original investment in 1989 was made in Gillette preferred stock, which was converted into common stock in 1991. In 2005 Procter & Gamble (PG) acquired Gillette, which is how Buffett ended up with Procter & Gamble (PG) stock in the process. Check my analysis of Procter & Gamble.

Buffett’s basis in Washington Post (WPO) is $6.15/share. With a current dividend of $9.40, Berkshire’s yield on cost is 153%. The Oracle of Omaha began acquiring stock in the prominent newspaper group in 1973.

The lesson to be learned from these investments is to purchase great businesses at fair prices. These businesses should have a strong competitive advantage, pricing power and generate excess returns without requiring a lot of capital to grow.

Full Disclosure: Long PG, KO, JNJ, KFT, WMT

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Seven dividend aristocrats that Buffett owns

Warren Buffett is arguably the best investor in the world. His main holding, Berkshire Hathaway (BRK.B) has delivered market beating returns during his leadership. Buffett’s strategy is characterized by purchasing stocks which have a long-term durable competitive advantage in a stable industry. Buffett then holds on to these companies and reinvests distributions either back into the business or by purchasing new businesses. In a previous article I mentioned that Berkshire’s portfolio has likely generated over $1.30 billion in dividends in 2009. Some of its holdings included seven dividend aristocrats.

Stocks which are included in the dividend aristocrat’s index represent companies which have raised dividends for over 25 years in a row. The companies included in the index represent some of the world’s most recognizable brands such as Coca Cola (KO), McDonald’s (MCD) or Procter & Gamble (PG). They have strong durable advantages, which have allowed them to increase profits and share the wealth with shareholders by consistently raising distributions, through several economic crises, oil shocks and asset bubbles. In addition to that these wide-moat companies derive substantial portions of their revenues globally, which makes them somewhat immune to local economic downturns.

I believe that by combining Buffett’s strategy of purchasing the companies with strong competitive advantages with my dividend growth strategy would produce exceptional results for enterprising dividend investors. The dividend stocks in Berkshire’s portfolio include:

Becton, Dickinson and Company (BDX), a medical technology company, which develops, manufactures, and sells medical supplies, devices, laboratory equipment, and diagnostic products worldwide. The company has increased its quarterly dividend in each of the past thirty-seven years. (analysis)

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. It principally offers sparkling and still beverages. The company has increased distributions for 47 consecutive years. I would be a buyer of KO below $54.66. Check my analysis of the stock.

Exxon Mobil Corporation (XOM) engages in the exploration, production, transportation, and sale of crude oil and natural gas. The company is a component of the S&P 500, Dow Jones Industrials and the Dividend Aristocrats indexes. Exxon Mobil has been consistently increasing its dividends for 27 consecutive years. I would only be a buyer of XOM on dips below $60. Check my analysis of the stock.

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company has boosted distributions to shareholders for 47 years in a row. I would be a buyer of JNJ below $65.33. Check my analysis of the stock.

Lowe’s Companies (LOW) is one of the original components of the Dividend Aristocrats . The home improvement retailer which operates the United States and Canada has increased its dividends for 47 consecutive years.

The Procter & Gamble Company (PG) engages in the manufacture and sale of consumer goods worldwide. The company operates in three global business units (GBUs): Beauty, Health and Well-Being, and Household Care. The company has rewarded stockholders with dividend increases for 53 consecutive years. I would be a buyer of PG below $58.67. Check my analysis of the stock.

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The world’s largest retailer has a 35 year record of annual dividend raises. I would be a buyer of WMT on dips. Check my analysis of the stock.

Full Disclosure: Long KO, JNJ, PG and WMT

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Buffett the dividend investor

Warren Buffett is the most successful investor of our time. The student of legendary value investor Ben Graham took on value investing to a whole new level by transforming the small textile mill Berkshire Hathaway (BRK.A) into a diversified conglomerate with interests in insurance, utilities, jewelry sales, newspaper publishing and many others.

Buffett is a closet dividend investor. One aspect of Buffett’s value strategy that many investors seem to miss is the fact that the Oracle of Omaha is a fan of companies which distribute a portion of their excess earnings back to Berkshire. This allows Buffett to re-invest the proceeds into new companies, which lets him further compound his invested capital.

Most of the companies which Berkshire has invested have been characterized by having wide moats, or durable competitive advantages. This is also the foundation behind some of the best dividend stocks out there. Only a company with a strong competitive advantage could afford to raise prices to consumers, which translates into higher earnings and ultimately into long-term dividend growth. Not having a large need of capital infusions is another important aspect of strong dividend growers.

Looking at the current portfolio holdings of Berkshire Hathaway, there companies. Of them seven are dividend aristocrats, one is an international dividend achiever and almost all of the rest pay a dividend except for six companies. Even some of Buffett’s core holdings such as GEICO and General RE, which he has acquired, were members of the elite dividend achievers index.

Berkshire Hathaway is expected to make about $1.3 billion in dividends from its publicly traded holdings. In addition to that Berkshire is expected to earn fat dividends from its investments in preferred stocks in General Electric (GE) and Goldman Sachs (GS) as well.



A major tenet of Buffett’s investment philosophy is buying a holding through thick and thin forever. It is especially interesting to note how much income his investment in Coca Cola (KO) and the Washington Post (WPO) generate. Berkshire’s average cost basis in Coca Cola is $6.49/share. With an annual dividend of $1.64/share Buffett is generating an annual yield on cost of 25.3%. This means that every 4 years he gets paid exactly what he paid for the stock 20 years ago. Buffett’s basis in Washington Post is $6.15/share. With a current dividend of $8.60, Berkshire’s yield on cost is 139.80%.

Full Disclosure: Long KO, JNJ, MTB, PG, WMT

This article was included in the The 241st Carnival of Personal Finance

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Berkshire Hathaway’s portfolio changes for 2Q 2009

Berkshire Hathaway (BRK-B) just posted its 13-F filing with the SEC, which lists changes in its stock positions.

Buffett initiated a new position in medical technology company Becton Dickinson (BDX) in the second quarter. The sec filing shows Berkshire Hathaway purchased.1.20 million shares in Becton Dickinson (BDX). Becton Dickinson is a dividend aristocrat, which has raised distributions for 36 years in a row.

Berkshire added 4.4 million shares to its position in health care giant Johnson & Johnson (JNJ). This is the second consecutive addition to its holdings there. Johnson and Johnson (JNJ) is another dividend aristocrat, which has rewarded shareholders with 47 years of consecutive dividend increases. Check my analysis of the stock.

Those recent moves by Buffett reiterate my convictions that he is a closet dividend investor. Most companies that have managed to increase their dividends for long periods of time are ones that have wide moats as well as excellent competitive advantages in the marketplace. Having these qualities leads to rising earnings which tend to support a steady pace of increase in dividends.

Berkshire eliminated its position in utility company Constellation Energy (CEG). This wasn’t a surprising move since Buffett’s company had already disclosed this sale in a June 1 filing.

Berkshire Hathaway disclosed lowered stakes in Carmax (KMX), ConocoPhillips (COP), Eaton Corporation (ETN), Home Depot (HD), United Health Group (UNH) when comparing June 30 to March 31 filings.

In a July 22 filing Berkshire Disclosed it had also cut its stake in the credit rating company Moody’s (MCO) by 16%.

Over the past several months Berkshire Hathaway has been allocating funds to preferred stocks with at very good prices. The company has invested billions in preferred shares of companies like Goldman Sachs (GS), General Electric (GE), Tiffany’s (TIF), Harley Davidson (HOG) and Dow Chemical (DOW). Some of these deals deliver not only solid yields in the low double digits, but also give warrants which could provide solid capital gains if these stocks recover over the next few years.

What this filing does not show however is the fact that Buffett’s conglomerate “goofed on derivatives”. While there may be more buzz than actual news and the SEC issues have been resolved, it is interesting how Buffett talks one thing but then does exactly the opposite of what he preaches. He’s always held a view against derivatives, yet his company has always engaged in options selling, futures and insurance derivatives.

One of his riskiest trades is the selling of puts on four major world stock indices, which expire somewhere between 2018 and 2028. Berkshire assumed over $37.50 billion in potential liabilities in the process, and has already lost $8 billion on them at the end June 2009. If world stock markets resemble the Japanese stock market of the second “lost decade” for the country with the rising sun, then Berkshire would be on the hook for almost half the $37 billion in assumed liabilities.

Does is pay to follow Buffett’s moves? The answer is yes it does. According to this paper a portfolio that mimicked Buffet’s stock investments would have outperformed S&P 500 by 14.6% annually between 1976 and 2006. Here’s a list of Berkshire Hathaway’s portfolio holdings as of June 30, 2009:



Full Disclosure: Long JNJ

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Buffett Partnership Letters

I recently managed to get a hold of the letters of the original Buffett Partnership. In those letters Warren Buffett describes the investment strategies employed by the partnership, the structure of the partnership as well as the fees that the limited investors paid for performance.

These partnership letters are different than Berkshire Hathaway’s (BRK.a, BRKb) letters to shareholders. Buffett wrote them between 1959 and 1969 and sent them out to the limited investors of the Buffett Partnership. He also provides additional information, which allows aspiring value investors to better understand how the young Buffett made his investment decisions early in his career.

The fees that Buffett was charging his limited partners were solely based on his performance. After all the partnerships merged into a single one in 1962, Buffett would get 25% of any profits over 6% that he partnership generated. In other words, if the partnership earned less than 6%, which was most probably how much it could have earned in fixed income, Buffett would get not compensation.

In one of his 1962 letters to limited partners, Buffett explained in detail the strategies he used to generate excessive returns.

The first group of companies (generals) he invested in was undervalued securities, where his partnership would hold about 5-10% of total assets in 5-6 companies and smaller positions in another ten or fifteen stocks. This group of stocks provided a relative margin of safety when purchased but behaved just like the market. Overall his portfolio in this section was relatively diversified, and but had a very good chance to generate excessive returns in up markets. One site that provides good ideas on generals is Old School Value.

The second group of companies that Buffett Partnership LTD tended to focus on was workouts. Those were stocks affected by corporate events like mergers and acquisitions, spin-offs, reorganizations and liquidations. Buffett did mention that this strategy would produce relatively stable earnings from year to year, which would make this portion of his portfolio outperform the markets in bad years, but underperform in strong markets. An example of such activity is the Pfizer/Wyeth merger announced in January 2009.

The third strategy where the Buffett Partnership concentrated was control situations. These were events where the partnership would initiate a large enough position in a company and try to influence corporate policy. A famous control situation is Berkshire Hathaway (BRK.A), which started out as an undervalued position.

Another important fact is that Buffett put his money where his mouth was – most of his net worth was invested in the Buffett partnership. In my research of successful companies I have found out that management which has a large chunk of their net worth in company stocks, tend to deliver more and are less likely to de-fraud individual investors. Companies where owners hold a large chunk of their net worth include Bill Gates holdings in Microsoft (MSFT), Richard Kinders holdings in Kinder Morgan (KMP) and John D. Rockefeller’s Standard Oil in the late 19th and early 20th century.

You could download them all from this link.

Here’s a timeline of the life of the Buffett Partnership:

1956 - Benjamin Graham retired and closed his partnership. At this time Buffett's personal savings were over $174,000 and he started Buffett Partnership Ltd., an investment partnership in Omaha.
1957 - Buffett had three partnerships operating the entire year.
1958 - Buffett operated five partnerships the entire year.
1959, -The company grew to six partnerships operating the entire year.
1960 -Buffett had seven partnerships operating: Buffett Associates, Buffett Fund, Dacee, Emdee, Glenoff, Mo-Buff and Underwood. In
1962- Buffett merged all partnerships into one partnership.
1966 -Buffett closed the partnership to new money.
1969 - Following his most successful year, Buffett liquidated the partnership and transferred their assets to his partners. Among the assets paid out were shares of Berkshire Hathaway.

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Myths about Warren Buffett

Warren Buffett is the richest investor in the world. The student of the father of value investing Ben Graham, learned how to invest money in the Graham-Newman Corp. partnership in the early 1950s. After it was closed, Buffett formed his own investment management partnership. In it, he utilized several value investment strategies, which allowed him to significantly outperform the S&P 500 for over a decade. In the early days of his partnership it was pretty easy to uncover value investment opportunities, since the partnership was small enough to deal where few investment advisers and mutual funds had the insight to operate.

In 1969, Warren Buffett closed his partnership, citing the fact that the market was overpriced and that bargains fitting the strict value investing principles that Graham taught him were tough to uncover.

At the same time he concentrated his actions on a small textile operation called Berkshire Hathaway, which is his flagship holding company. His success at Berkshire is astounding, but it is not merely due to value investing strategy, as is commonly known. Had Buffett not branched out of strict value investing principles that Graham taught him; Berkshire Hathaway would have remained a relatively small conglomerate. Buffett did branch out into other strategies however. His insurance operations are similar to selling naked puts or calls – he generates enough premium which in most cases doesn’t have to be paid out for many years to come, giving him a low cost source of financing. His recent deal to sell long term puts (LEAPs) on four major stock indices is another example of branching out.

Buffett also essentially shorted the US dollar. In 2002, Buffett entered in $11 billion worth of forward contracts to deliver U.S. dollars against other currencies. By April 2006, his total gain on these contracts was over $2 billion. In 2005 he reduced his exposure to the currency futures he was holding. His play on the weakening dollar is by purchasing solid businesses which derive a portion of their earnings from outside the US.

Most people I talk to also seem to believe that Buffett owns a concentrated portfolio of 10-15 positions, which allows him to allocate the most funds in his best ideas. A recent look at Berkshire Hathaway’s stock portfolio revealed 40 stock positions from a variety of industries such as consumer staples, utilities, financials, retailers, energy and many other sectors. In addition to that Berkshire Hathaway owns a variety of businesses ranging from insurance ( Geico and General RE) , Utilities ( Mid american), Apparel, Building Products, Flight Services, Retail, Financial, and Conglomerates such as the recently acquired Marmon Holdings.

Another example is his investments in Gillette, acquired by Procter and Gamble(PG) ; Coca Cola (KO) and Johnson & Johnson (JNJ). Buffett purchases businesses with wide moats, which he believes have strong growth potential, that would lift earnings and distributable cash flows. His yield on cost on his 1988-1994 $1.298 billion investment in Coca Cola (KO) is a staggering 25.20%. His average purchase price comes out to $6.49/share, whereas the annual dividend is $1.76/share after the most recent dividend increase.

Another interesting investment is in See’s Candies, which he purchased for $25 million in 1972, at a time when its pre-tax earnings were $5 million on $30 million of sales. The confectionary maker in a slow growth industry currently generates enough cash flow, which is then redirected to other business opportunities. In fact over the past 35 years, the capital needs for the company have risen from $8 million to $40 million annually, while it has returned $1.35 billion worth of pre-tax earnings to be allocated somewhere else.

Yet another myth about Buffett is that he doesn’t like dividends. The contrary is true – from his early days of buying farmland and operating a newspaper route to buying pinball machines Buffett has been particularly interested in the distributions from his business. His investments in See’s Candies and other businesses like Coca Cola (KO) and Johnson & Johnson (JNJ) throw off enough cash in the form of dividends to Berkshire Hathaway that he then allocates appropriately. The same is true for many dividend investors, which are primarily interested in purchasing stable wide moat businesses, that have the ability to grow earnings. That way these companies can afford to consistently raise distributions to shareholders. Dividend investors then allocate their dividends received in the best manner suitable – either by purchasing more stock or spending it on their own needs.

Another myth about Warren Buffett is that he never sells. In 1998 he sold his position in McDonald’s (MCD) for a tidy profit. In his 1998 Letter to Shareholders, Buffett called this move “a very big mistake”. While McDonald’s stock closed 1998 at $38 it did fall to as lot as $12 at the bottom of the 2000-2003 bear market, before staging a massive rally during the 2003-2007-bull market. The stock is one of the few, which have not seen their shares fall of a cliff in the recent bear market.

The future of Berkshire Hathaway is really what gives nightmares to its investors. Due to its sheer size, it has to concentrate only on opportunities in the billions of dollars. In “THE SUPERINVESTORS OF GRAHAM-AND-DODDSVILLE” he explained that “if you ever get so you're managing two trillion dollars, and that happens to be the amount of the total equity valuation in the economy, don't think that you'll do better than average”

It would be impracticable to concentrate on hundreds of smaller deals, which could potentially generate higher returns. One idea that Berkshire could implement is to franchise Buffett Partnership’s business model to hundreds of small value investors with $1 million in seed capital, and watch them become the next Buffett. This could bring in new life to Berkshire.

Buffett seems to like companies, which generate enough in royalties due to their high moats for many years to come. Such competitive advantages that allow them to spend a considerable amount of funds upfront on research and development to create a unique product and then sell it for many years in the future is closely resembling the idea of passive income that many investors are constantly seeking out. Such companies which generate “royalty” type of revenues includes See’s Candies, Microsoft (MSFT), Coca Cola (KO), and pharmaceuticals companies such as Pfizer (PFE) or Eli Lilly (LLY).

Below I have summarized some interesting materials I found about Buffett:

Buffett Partnership Letters

http://www.ticonline.com/buffett.partner.letters.html

Berkshire Hathaway Shareholder Letters

http://www.berkshirehathaway.com/letters/letters.html

Buffett’s E-mail correspondence about Microsoft

http://thomashawk.com/2005/12/1997-email-from-microsofts-jeff-raikes.html

THE SUPERINVESTORS OF GRAHAM-AND-DODDSVILLE

http://www.tilsonfunds.com/superinvestors.pdf

This article was featured in the Carnival of Personal Finance: New Zealand Edition!

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Warren Buffett’s Berkshire Hathaway Portfolio Changes for Q1 2009

The long awaited disclosure from Berkshire Hathaway about its holdings is online. This time however many are doubting Buffett’s wisdom after his stock lost over 32% of its value in 2008 versus S&P 500's 36.7% loss. He also made some derivative bets on indexes which are misunderstood by most market participants. Year to date Berkshire Hathaway stock is down 7.75%, and is trailing the S&P500’s year to date gain of 2.43% by a wide margin. Over the past 30 years however, Berkshire Hathaway has significantly outperformed the S&P 500.

There were changes in ten positions owned by Berkshire Hathaway.

The companies where Berkshire added to positions included Burlington Northern Santa Fe (BNI), Wells Fargo (WFC), US Bancorp (USB), Nalco (NLC), Johnson & Johnson (JNJ) and Union Pacific Corp (UNP).

His addition to positions in Wells Fargo and US Bancorp seem to have been made at particularly challenging conditions near the 52-week lows for both stocks. Once again Buffett seems to have followed his strategy of being greedy when others are being fearful, by loading up on the above stocks.

Another interesting trend is that Buffett keeps adding to his positions in railway stocks, especially Burlington Northern. The purchase of additional Johnson & Johnson is a bullish sign as well. Berkshire sold over 33 million JNJ shares back in the fourth quarter of 2008 in order to generate enough cash to participate in the preferred stock offerings of several companies including General Electric (GE) and Goldman Sachs (GS).

The companies where Berkshire trimmed positions include Carmax (KMX), Constellation Energy Group (CEG), ConocoPhilips (COP) and United Health Group (UNH).

The most interesting trade here is his selling of a large chunk of ConocoPhillips shares. Berkshire initiated a position in COP back in 2008 when oil and gas prices were at their peak. Now it appears that he is selling the stock just before oil prices have resumed their upward trend. The Oracle from Omaha’s words on his investment in Conoco are an interesting glimpse in his decision making process:

“We sold 13.7 million shares of ConocoPhillips during the first quarter and additional shares were sold subsequent to the end of the quarter. Although we expect the market price of ConocoPhillips to increase over time to levels that exceed our original cost, we are likely to sell some additional shares prior to that time and generate additional capital losses that we can carry back to prior tax years when we generated net capital gains. In 2006, we paid about $690 million in federal tax on capital gains and that payment can only be fully recovered if capital losses of at least $1.98 billion are taken in 2009.”

The number of Conoco shares that Berkshire owns is most probably lower than what the filing shows. The same is true for Berkshire’s position in Constellation Energy (CEG) as well.
Does is pay to follow Buffett’s moves? The answer is yes it does. According to this paper a portfolio that mimicked Buffet’s stock investments would have outperformed S&P 500 by 14.6% annually between 1976 and 2006.

Here's a list of Berkshire Hathaway holdings as of March 31, 2009.

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What I learned from Warren Buffett’s Most Recent Letter to Shareholders

Warren Buffett’s iconic letter to shareholders has been published on Berkshire Hathaway's website. The legendary chairman of Berkshire Hathaway has been writing this annual letter for more than 32 years. In it he summarizes the performance of the various businesses that make up the portfolio of his conglomerate. The Oracle of Omaha often gives insight on his decision making process, when making investments.

Of particular importance to me were his words on his reduction of stakes in Johnson and Johnson (JNJ), Procter and Gamble (PG) and Conoco Phillips (COP):

"On the plus side last year, we made purchases totaling $14.5 billion in fixed-income securities issued by Wrigley, Goldman Sachs and General Electric. We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three purchases, we also acquired a substantial equity participation as a bonus. To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips). However, I have pledged – to you, the rating agencies and myself – to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits."

I speculated before that one reason why he might be selling solid dividend stocks such as Johnson & Johnson and Procter and Gamble could be that they haven’t fallen as much as the broader market, which makes them ideal for Buffett to deploy the funds in other beaten down sectors. Another reason could be that he needs to raise as much cash as possible, in order to participate in other preferred stock or fixed income deals, where he could earn a 10%-15% annual dividend yield, with very favorable terms for his company. Ordinary investors do not however have the purchasing power to participate in such favorable deals at this time.

Buffett also spend several pages discussing derivatives and shortcomings of the Black Scholes option-pricing model.

Full Disclosure: Long JNJ, PG

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Should you follow Warren Buffett’s latest moves?

Berkshire Hathaway (BRK-A, BRK-B) published a glimpse of its stock portfolio holdings as of December 31,2008, on the SEC website. I have highlighted the largest changes in shares owned.


In the last quarter of 2008 Warren Buffett kept adding to his Burlington Northern (BNI) position by purchasing well over 6 million shares for Berkshire’s account. He also added to his positions in Ingersoll- Rand (IR), NRG Energy (NRG), and Eaton (ETN). He initiated positions in Constellation Energy Group (CEG) using his Midamerican subsidiary and in Nalco (NLC).

Buffett was not only buying American however. He was selling as well. Berkshire cut its stake in Johnson & Johnson (JNJ) by half to 28 million shares. Other notable decreases included Procter & Gamble (PG), US Bancorp (USB), Conoco-Phillips (COP) and Carmax (KMX). Berkshire also disposed of all of its Anheuser-Busch stock, which was tendered at $70/share after the merger with InBev. The holdings in other financial stocks such as Wells Fargo (WFC), American Express (AXP), Moody's (MCO) and Bank of America (BAC) were mainly unchanged for the quarter.

The value of Berkshire’s portfolio dropped to $51.87 billion from $69.89 billion at the end of third quarter 2008. Even the Oracle of Omaha is not immune to market corrections, especially now that his asset base is so huge. Berkshire Hathaway shares dropped by 26% in the last quarter of 2008, compared with a 21.5% drop for the broad S&P 500 index. So far this year both S&P 500 and Berkshire Hathaway stock are down between 12.20% and 13% each respectively.
Given the changes in Berkshire Hathaway’s portfolio, I would not recommend acting similarly in your personal investments, based solely on following Buffett’s moves. One reason why he might be selling solid dividend stocks such as Johnson & Johnson and Procter and Gamble could be that they haven’t fallen as much as the broader market, which makes them ideal for Buffett to deploy the funds in other beaten down sectors. Another reason could be that he needs to raise as much cash as possible, in order to participate in other preferred stock or fixed income deals, where he could earn a 10%- 15% annual dividend yield, with very favorable terms for his company. Ordinary investors do not however have the purchasing power to participate in such favorable deals at this time. His list of fixed income or preferred stock investments range from Goldman Sachs, General Electric, USG, Swiss Re, Harley Davidson and Tiffany’s.

As a dividend growth investor, I still consider Procter & Gamble and Johnson & Johnson one of the essential holdings in my dividend stock portfolio. Warren Buffett is not always right when it comes to selling. He did sell his stake at McDonald's (MCD) in 1998. In his 1998 Letter to Shareholders he mentioned that "In particular, my decision to sell McDonald's was a very big mistake.Overall, you would have been better off last year if I had regularly snuck off to the movies during market hours."

Full Disclosure: Long GE, JNJ, PG, MCD

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Warren Buffet's Luxury Dividends at Tiffany’s

Warren Buffett is on the move again by purchasing $250 million worth of debt from Tiffany’s. Half of the debt will mature in 2017, while the rest will mature in 2019.
Tiffany said the proceeds of the Notes will be used to refinance existing indebtedness and for general corporate purposes. Unlike Berkshire’s investments in General Electric and Goldman Sachs, these notes do not have warrants attached to them.
This is another one of the legendary Wizard of Omaha investments in high profile companies. His list of fixed income or preferred stock investments range from Goldman Sachs, General Electric, USG, Swiss Re and Harley Davidson. In his article "Buying American", Buying American, Buffett expressed his bullishness on the future of US economy and stock market. Once again however, it’s always good to read between the lines, as Buffett’s Berkshire Hathaway doesn’t seem to have purchased any common stock in the above-mentioned names. His holding company has rather gained preferential terms with the companies that received “Berkshire Hathaway Troubled Assets Relief Program”, as his name carries a very good premium. After the closing bell, Berkshire will file its portfolio "snapshot" taken at the end of the quarter, on December 31.
I would not be investing in Tiffany’s based off Buffett’s fixed income play there; the company does appear to have a good presence in the luxury goods market. The current crisis hasn’t missed this jewelry retailer, which warned last month that its same-store sales for the holiday season fell 24 percent as sales slowed in its domestic stores.
It would be interesting to note if TIF would keep its dividend payment. Other similar Berkshire investments such as Harley Davidson cut their dividend payments just days after announcing Buffett’s investment in their fixed income notes. General electric on the other hand has not announced any cuts, although many investors believe that the dividend is on the chopping block.

Full Disclosure: None

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Warren Buffet’s Investment in Harley-Davidson, don’t get too excited about it

Shares of Harley Davidson, which is a dividend achiever, got a big boost yesterday, after legendary investor Warren Buffett snapped half of the company’s $600 million in bonds that will be issued. The bonds will mature in 2014 and carry an annual interest rate of 15%.
Warren Buffett made similar investments in fixed income equivalents (preferred stock) in General Electric and Goldman Sachs, both of which carried a 10% interest rate. Unlike GE and GS’s investments however, the 300 million-bond position that Buffett’s Berkshire Hathaway (BRK.a) is taking won’t come with a warrant to purchase some of Harley Davidson’s stock.

The money will help Harley Davidson in its three-part strategy that it issued in January, after losses in its finance unit led to a 58% drop in 4Q earnings. The strategy includes investing in the Harley-Davidson brand, getting a leaner cost structure as well as securing additional funding for its finance unit, which makes loans to dealers and customers.

The investment in Harley by Warren Buffett led to a huge increase in HOG stock, as it provided a huge dose of support for the brand. Investor’s shouldn’t get too excited about this deal however by purchasing Harley-Davidson stock. Buffett is definitely getting a sweet deal in Harley’s effort to capitalize on his name and get enough cash to sustain the company through the tough times. If Buffett believed that Harley’s stock is undervalued he would have purchased the stock directly. Since he is only purchasing bonds, without any warrants that would convert the bonds into equity, it definitely looks that he doesn’t believe Harley is undervalued enough for him to take an equity position. For ordinary investors however, getting in on a deal with similar terms is close to impossible.

In 2008 Buffett took perpetual preferred stock positions in General Electric and Goldman Sachs, for $3 billion and $5 billion respectively. According to the deal with Goldman, which was announced on September 23, the preferred stock has a dividend of 10 percent and is callable at any time at a 10 percent premium. Berkshire Hathaway (BRK.a) also received warrants to purchase $5 billion of common stock with a strike price of $115 per share, which is exercisable at any time for a five-year term.

According to the deal with General Electric, which was announced on October 1, the perpetual preferred stock has a dividend of 10% and is callable after three years at a 10% premium. Berkshire Hathaway (BRK.a) also received warrants to purchase $3 billion of common stock with a strike price of $22.25 per share, which is exercisable at any time for a five-year term.

Investors who mistakenly believed that these investments in General Electric and Goldman Sachs could be replicated by purchasing the common stock have lost a lot of money in the process. GE shares lost almost half of their value, while GS stock lost roughly one third.

Several pundits have also expressed concerns that Buffett suffered major losses on his investments in General Electric and Goldman Sachs. This delusion comes from confusing option strike prices with actual purchase prices. The options to purchase GE and GS stock give Buffett the right, but not the obligation to acquire shares in both companies at $22.25 and $115 per share respectively by 2013. In the meantime he is being paid $800 million/year in dividends.

As a dividend and value stock, Harley Davidson does appear undervalued. The dividend is well covered and the P/E is only at 5. This reflects investors’ worries that the downward EPS trend from 2006 record earnings of $3.94/share might continue over the next few years.

It will be interesting to see how the company copes with the uncertain economic climate. Harley Davidson is a great american brand, with a loyal customer base, which is most probably why Buffett bought 300 million in bonds in the first place. Since the company’s products are discretionary however, its target audience might delay purchases of new bikes for the time being.

Full Disclaimer: Long GE stock

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