Wednesday, May 2, 2012

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

Relevant Articles:

Warren Buffett – A Closet Dividend Investor
Seven wide-moat dividends stocks to consider
Strong Brands Grow Dividends
Dividend Investing Misconceptions


  1. It seems like Buffet is also focused on finding businesses that are operating efficiently and effectively (per his criteria in the shareholder letters) and that have great managers. Unfortunately, assessing management's ability is one of the harder jobs (in my opinion). Especially as a retail investor, as it is hard enough to get responses from most company's investor relationships, much less actually talking with senior management.

    It also seems that as Berkshire Hathaway has grown, that he is focusing more on capital intensive businesses (other than the insurance section of the company), such as the railroad and Mid American, as they are about the only things that can really even attempt to move overall earnings at this point.

  2. Yes a very good pack of shares. I would also ad Intel as its figures are also quit good with high equity level and good liquidity compared to >1 of PG and WM

  3. The Warren Buffet ways of investing are diligently followed by financial enthusiasts.

    The fundamental rule of financial management that is necessary to be taught to all is to LIVE WITHIN THEIR MEANS. Credit cards are very handy and convenient but it is never necessary to buy things on credit. Overspending may be crawling in your system without you knowing it.

  4. Interestingly, even when he gets involved in non-dividend payers he gets his stream of income (BAC and GS)

  5. Those companies are great companies but what about higher yield dividend companies that have a good stream of revenue but have not been in business too long? Buy or avoid?

  6. Can you clarify--in a dividend growth portfolio do you reinvest the dividends automatically? or do you take the dividends as cash and then periodically reinvest? I do the former because currently the payouts i receive are small in relation to a trading commission. thanks.


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