It's no secret that Warren Buffett is one of the best investors alive, delivering investors returns of 20% compounded annually since becoming chief executive officer of Berkshire Hathaway in 1965.
Numerous factors can explain Buffett's success, and an important one is his love of dividend stocks. Dividend stocks are a great source of returns in the market and, according to Fidelity, have accounted for 40% of the S&P 500's total returns since 1930. When inflation is high, as it was in the 1940s and 1970s, dividend stocks accounted for as much as 71% of the market's returns.
Dividend-paying companies tend to have strong businesses that generate consistent cash flows, making them stellar long-term investments. Here are three Buffett stocks that net the Oracle of Omaha high dividend yields relative to what Berkshire Hathaway paid for the stock.
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1. Moody's: 27.9% yield, relative to cost basis
Moody's (MCO 1.26%) provides credit ratings to companies across the globe and is an essential player in the fixed-income market. The credit ratings business has huge barriers to entry, making it difficult for new companies to enter the space. As a result, a few companies dominate the industry, with Moody's and S&P Global as the leaders with a 40% market share each.
Last year, Moody's benefited as $2.3 trillion in corporate debt was issued, a record amount. Moody's gains from low interest rates, which encourage businesses to issue more debt as they expand.
Rising interest rates will put a damper on this business, which saw revenue decline 20% in the first quarter compared with the previous year. Management at Moody's expects its ratings business revenue growth to decline to the low-double digit percentages but sees revenue from its analytics business increasing in the high teens. In the first quarter, analytics business revenue increased 23%, marking the fifth consecutive quarter of growth from the segment.
Moody's is a longtime holding of Berkshire's, which has an ultra-low average cost of about $10 per share, giving it an impressive 27.9% dividend yield relative to its cost basis.
2. Bank of America: 5.9% yield, relative to cost basis
Bank of America (BAC 1.59%) provides banking services across the globe and is the second-largest bank in the U.S. with $2 trillion in deposits, behind only JPMorgan Chase. It's also Berkshire Hathaway's second-largest holding.
The Federal Reserve is aggressively raising interest rates to combat inflation, which can benefit bank stocks. Banks traditionally make money from net interest income, the difference between interest paid on deposits and interest collected from loans.
The Federal Reserve recently raised its benchmark interest rate by 0.75% as it tries to reel in inflation. The benchmark interest rate now sits between 1.5% and 1.75% and will continue to rise through the year, as Fed officials forecast the rate to be around 3.4% by year-end.
Target Federal Funds Rate Upper Limit data by YCharts
One factor investors must consider is that if interest rates rise too quickly they could stifle consumer demand, which could lead to reduced economic growth and slower loan growth for banks.
While there are fears of a recession on the horizon, Bank of America is well positioned to benefit from rising interest rates in the long run, which is why Buffett likes the stock so much. In its March 31 filing, Bank of America noted that a 1% increase in interest rates would cause net interest income to grow by $5.4 billion, or a 12% increase from 2021.
Berkshire Hathaway has an average cost of $14.17 on its Bank of America stock, giving it a 5.9% dividend yield relative to its cost basis.
3. U.S. Bancorp: 4.9% yield, relative to cost basis
U.S. Bancorp (USB -3.61%) provides banking services through its 2,200 branches across the Midwest and West regions of the U.S. and is one of Berkshire Hathaway's top 10 largest holdings.
The bank also benefits from rising interest rates more than other banks because it doesn't have an investment banking division to boost earnings. Instead, it focuses on traditional banking activities of lending money and growing deposits.
U.S. Bancorp is laser-focused on increasing loans and is selective about the loans it is willing to make, concentrating only on high-quality credits. As a result, the bank has a return on equity (ROE) that has outpaced its banking peers for years.
USB Return on Equity data by YCharts
Last year, the bank sacrificed short-term profits so that it could have the financial flexibility to take advantage of higher interest rates this year and beyond. The bank's net interest income grew by 3.6% in the first quarter. In its March 31 filing, it projected a 2% increase in interest rates would increase its net interest income by another 3.3%.
Berkshire Hathaway has an average cost of $37.51 in U.S. Bancorp stock, giving it a 4.9% dividend yield relative to its cost basis.
