Wednesday, March 9, 2011

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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  1. Amazing article!! I am a huge Warren Buffer follower and love the strategy/game plan he has when he invests into companies. It is all about consistent dividends, as that really will push the return on your investment higher.

    Even though the companies may not be as exciting or display a "speculative" high growth opportunity, investing doesn't have to be a rollercoaster ride. Dividend investing has long been proven to work and as a rational investor, one should identify that and pursue similar strategies. Great Post!

    -Lanny B.

  2. Buffet***** Can't believe I misspelled it!!

  3. Love it...great story about long-term investing. 153% yield on

  4. I have some older clients that have stocks that pay more in quarterly dividends than their cost basis. Dividends aren't a secret, never have been......Wall street just doesn't play it up because they are too busy trying to sell the sizzle of growth and not the steak. You can't charge high fees to collect dividends.

  5. So, I just now noticed that Kinder Morgan did an IPO (in Feb) for the general partner interest in Kinder Morgan under the symbol KMI, as opposed to the limited partner interest KMP/KMR. Any thoughts on KMI alone or as compared to KMP/KMR?

  6. I too am a follower of Buffett and had never really bothered to add up all the dividends like you have in this article. Imagining $1.3 billion in dividends alone over and above any profits he makes on his varied businesses explains why he is the greatest investor of all time.


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