Dividend stocks are usually the cornerstone of successful investing portfolios. That's because they bring an abundance of advantages to the table that their non-dividend-paying counterparts simply can't offer.
Aside from the fact that dividend stocks have handily outperformed non-dividend-paying stocks over the long run, the first thing to note is that dividend stocks are usually profitable and have time-tested business models. Put in another context, companies wouldn't be inclined to share a percentage of their income with shareholders if their management teams didn't foresee continued profitability and growth.
Furthermore, regular payouts can help calm skittish investors and hedge against inevitable stock market corrections, as well as be reinvested into more shares of dividend-paying stock via a dividend reinvestment plan (DRIP). DRIPs are how the smartest money managers in the world generate long-term wealth for their clients.
Warren Buffett loves dividend income
The importance of dividend payouts isn't lost on the most revered buy-and-hold investor of our generation, Warren Buffett. The CEO of conglomerate Berkshire Hathaway (NYSE:BRK-B)(NYSE:BRK-A) is currently generating dividend income from roughly two-thirds of the nearly four dozen companies in which he has an investment stake. By as early as next year, Berkshire Hathaway might be able to generate north of $5 billion annually in dividend income.
Whereas most of Buffett's dividend stocks offer modest yields that are more or less in line with the average yield of the broad-based S&P 500, a closer inspection of Berkshire's holdings reveals three high-yield dividend stocks that are currently yielding at least 4%. That's more than double what investors could pocket in annual income from a 10-year Treasury note from the U.S. government.
Additionally, these high-yield stocks also happen to be three of Buffett's 14 largest holdings by total market value. As such, it's not a stretch to consider these established businesses his favorite high-yield stocks.
Of course, you're about to see that a high yield isn't necessarily a good thing -- even for the Oracle of Omaha.
Kraft Heinz: 6% yield
One of the biggest dangers of dividend investing is yield-chasing. Since yield is simply a function of payout relative to share price, a struggling business with a flailing share price can present with an exceptionally enticing yield. That's exactly what's happened with snack and beverage company Kraft Heinz (NASDAQ:KHC), which has lost 38% on a year-to-date basis, inclusive of dividend payouts, and seen its payout soar to 6%.
When Berkshire Hathaway and 3G Partners teamed up to buy Heinz in 2013, they saw a company with well-known food brands that, in many instances, had little trouble engaging consumers. However, Heinz clearly overpaid for Kraft Foods in 2015, which is something that the Oracle of Omaha admitted when speaking with shareholders during the company's latest annual shareholder meeting.
Despite Kraft Heinz's recent struggles, Buffett has no intention of selling Berkshire Hathaway's 325.6 million share stake in Kraft Heinz, worth about $8.8 billion. However, this decision has more to do with Buffett not wanting to further pressure Kraft Heinz's share price by trying to dispose of Berkshire's 26.7% stake than confidence in the company's ability to turn itself around. Kraft Heinz's balance sheet is currently bogged down by $29.8 billion in long-term debt and $36 billion in goodwill, even after writing down $15.4 billion of the value of various brand-name products earlier this year. The company needs capital to reignite growth in its brands, but is busy tightening its belt to reduce its expenditures.
Kraft Heinz may be a significant income generator for Buffett, but it's not the strongest dividend stock by any means.
General Motors: 4.4% yield
A considerably more solid business model in Berkshire's portfolio is Detroit automaker General Motors (NYSE:GM), which is currently yielding 4.4%. But make no mistake about it, GM isn't without its issues.
General Motors is currently contending with a United Auto Workers strike that's impacting 30 factories and is well into its third week. It's the third-longest strike over the past five decades, and it's cost the company more than $1 billion during the third quarter, according to estimates from analysts at JPMorgan Chase.
There have also been rumblings that auto sales are cyclically peaking, which has put pressure on General Motors' share price since late July, thereby pushing its dividend yield higher.
But unlike Kraft Heinz, there are immediate bright spots for General Motors. For one, while strikes are never a good thing, they usually don't last too long or have a lasting impact on operating results. If anything, it's made for some very beatable comps in 2020.
More importantly, tempered gas prices have allowed GM to see ongoing relative strength in higher-margin trucks and crossover vehicles in the United States, as well as its premium Cadillac brand in China. While China's economic contraction has taken a toll on GM's near-term growth, the company's higher-margin vehicles have shown resilience during this weakness. At a mere five times Wall Street's consensus earnings per share for 2020, General Motors looks to be a bargain for income investors.
Wells Fargo: 4.2% yield
Lastly, there's one of Buffett's longest-held stocks: money center bank Wells Fargo (NYSE:WFC). A fixture in Buffett's portfolio for the past 30 years, Wells Fargo currently accounts for $20 billion in market value and is paying out a healthy 4.2% yield.
To some extent, Wells Fargo's superior yield among big-money banks has to do with its share price moving very modestly lower over the trailing five-year period. In 2016, the Wells Fargo scandal hit the newswires, with the company admitting to opening 2.1 million fake accounts in light of aggressive branch-based cross-selling tactics. The following year, an internal audit revealed this figure to be closer to 3.5 million fake accounts, further hurting consumers' trust in the bank. This is a big reason Wells Fargo's share price has been stuck in neutral for years.
However, much like GM, Wells Fargo has factors working in its favor that should put a smile on Buffett's face. To begin with, consumers tend to have very short-term memories when it comes to banking scandals. Remember, it was less than a decade ago that Bank of America tried to charge its debit cardholders to use their cards, as well as paid more than $60 billion in cumulative fees tied to mortgage misdoings. Those issues have long since been put in the rearview mirror for Bank of America, and the same will likely be true for Wells Fargo.
Also, it's important to recognize that Wells Fargo has a history of successfully attracting affluent clients, who ultimately have fueled its loan-based income growth. Despite trust concerns, Wells Fargo's return on assets remains among the best for money center banks.