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Dividend cuts and suspensions have wiped out 20% of Berkshire Hathaway's income stream.
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Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) CEO Warren Buffett may well be the greatest investor of our time. We're talking about someone who first began investing in the stock market at age 11, and who built a roughly $10,000 nest egg in the 1950s into a net worth of $74 billion today. Mind you, this figure would be tens of billions of dollars higher had Buffett not generously donated to charities throughout the years. He's also created nearly $400 billion in value for Berkshire Hathaway's shareholders over the past five-plus decades.
While Buffett's buy-and-hold investment strategy has played a big role in his success, the importance of dividend stocks in Buffett's investment portfolio shouldn't be overlooked.
Berkshire Hathaway CEO Warren Buffett at his company's annual shareholder meeting. Image source: The Motley Fool.
Historically, dividend stocks have run circles around their non-dividend-paying peers. This really shouldn't be all that surprising given that dividend stocks are usually profitable and have time-tested business models.
A report from J.P. Morgan Asset Management in 2013 found that companies initiating and growing their dividend between 1972 and 2012 delivered a compound annual return of 9.5%. By comparison, businesses that didn't pay a dividend delivered anemic compound annual gains of 1.6% over this same 40-year period. That's a nearly 500% better annual average return simply by choosing companies that pay a dividend. Typically, around two-thirds of the companies that Berkshire Hathaway owns a stake in will pay a dividend.
Dividend payouts can also be used to partially hedge against inevitable stock market corrections and bear markets. Although dividend yields won't offset big moves lower in the stock market, they can help long-term investors keep a proper mindset during periods of unrest and panic.
For the lay investor, dividend stocks also allow for reinvestment, via a dividend reinvestment plan (DRIP). By purchasing additional shares of stock with your payout, you'll boost your ownership in a presumably profitable and time-tested business, as well as set yourself up for progressively larger dividend payouts over time. This method of compounding wealth is what a lot of successful money managers employ to grow the portfolios of their clients.
Image source: Getty Images.
Earlier this year, I ran the numbers on Berkshire Hathaway's dividend-paying stocks and came up with $4.72 billion as the amount of dividend income Warren Buffett was liable to rake in this year. Keep in mind that this $4.72 billion figure did not include the $800 million in preferred cash dividends that Berkshire Hathaway was to net annually from its $10 billion investment in Occident Petroleum (OXY +0.01%) preferred stock. Thus, inclusive of this preferred stock position, Buffett's company should bring in around $5.5 billion in dividend income.
But this figure was calculated before the coronavirus disease 2019 (COVID-19) completely changed our societal habits and shut down nonessential businesses in most U.S. states. With over 1 million confirmed cases of COVID-19 in the U.S. alone and more than 26 million people losing their jobs in a four-week stretch, Congress and President Trump have had little choice but to offer financial assistance to small businesses, the unemployed, and even distressed industries.
The problem is that some industries simply aren't built to handle the level of disruption brought on by the coronavirus, including the highly cyclical airline, auto, and oil industries. As a result, dividend reductions or suspensions have become the norm of late.
In recent weeks, General Motors (GM +0.00%), American Airlines Group (AAL +0.01%), and Delta Air Lines (DAL +0.01%) all announced that they were suspending their dividends. Meanwhile, Occidental Petroleum wound up slashing its payout by 86% (to $0.11 per quarter from $0.78 per quarter), and it was forced to pay Berkshire Hathaway's latest preferred stock payout in common stock as opposed to cash. Though Occidental common stock is better than getting nothing at all, it doesn't offer the guarantee of a cash dividend.
How much has this cost Warren Buffett? Here's the annual rundown:
For you math-phobes out there, that's more than $1.1 billion in dividend income now lost, or 20% of what Berkshire Hathaway expected to generate as recently as two months ago.
As part of their bailout deal, airlines like American and Delta won't be able to buy back their stock or pay a dividend for quite some time. Meanwhile, Occidental is reeling from its debt-laden purchase of Anadarko and the greater than 75% cratering in West Texas Intermediate crude oil since the year began. Finally, General Motors shut down production in March and is targeting a May 18 reopening of its U.S. production plants. Whether consumers will be in a car-buying mood next month is a different question. All of these companies absolutely need to conserve cash now, and that's bad news for Buffett.
Then again, don't think you need to shed a tear for the Oracle of Omaha. Even if Berkshire Hathaway only generates $4.4 billion in annual dividend income moving forward, it'll still be yielding 4% annually based on its roughly $110 billion initial cost basis for all of its investments (including the $10 billion Occidental preferred stake).
Many of Buffett's top dividend stocks generate such abundant cash flow that there's virtually no chance of a payout cut in the foreseeable future.
For instance, beverage giant Coca-Cola (KO 0.01%) is on track to generate $656 million in dividend income this year for Berkshire Hathaway. Coca-Cola has the advantage of operating in all but one country worldwide (North Korea), and has more than 20 brands that bring in $1 billion or more in annual revenue. Coca-Cola is also one of the most-recognized brands in the world, which allows it to easily transcend generational gaps. In other words, its dividend is rock-solid, even with COVID-19 spreading globally.
The same could be said for tech giant Apple (AAPL +0.01%), which is set to supply Buffett's company with almost $773 million in dividend income this year. Even with an expected slowdown in Apple iPhone sales due to supply chain disruption, we're talking about a company that generated $73.2 billion in operating cash flow over the past 12 months, and that has a cult-like following for new product releases. With Apple also focusing on wearables and services, it'll come through the COVID-19 pandemic just as strong as it was before, if not stronger.