Warren Buffett is undoubtedly one of the best investors of the past half-century. Berkshire Hathaway's (BRK.A -0.67%) (BRK.B -0.65%) chairman and chief executive officer has built it into the largest investment holding company in the world.
The Oracle of Omaha was able to accomplish this spectacular feat with the simple investing strategy of buying businesses with reliably growing profits. The thought process behind this strategy is that rising earnings will also translate into dividend hikes. Here are two businesses in which Berkshire Hathaway owns stakes that could be good picks for dividend growth investors.
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1. Johnson & Johnson: The largest pharmaceutical company on the planet
With 140,000-plus employees throughout the world and a $415 billion market capitalization, Johnson & Johnson (JNJ -0.16%) is the biggest pharmaceutical company on Earth. The drugmaker also earns the distinction of being one of the smaller stakes within Berkshire Hathaway's portfolio, valued at $52 million.
As you'd expect from such a massive business, J&J boasts an impressive product portfolio: In 2022, the company's product portfolio included 14 blockbuster medicines (i.e., at least $1 billion in annual sales) and its blockbuster COVID-19 vaccine.
J&J's commitment to research and development is exactly what powered 5.5% annual non-GAAP (adjusted) diluted earnings per share (EPS) growth over the last five years. And with 109 projects currently in clinical development as of last month, the future should be just as bright for J&J. That's why analysts are projecting mid-single-digit annual adjusted diluted EPS growth from the company over the next five years as well.
While Berkshire Hathaway has stuck to reinvesting its profits for future growth, the Nebraska-based business has a clear preference for dividend-paying stocks: Berkshire Hathaway is on pace to receive over $6 billion in dividend income from its holdings this year.
Income investors will also love J&J's 2.8% dividend yield, which is well above the S&P 500 index's average 1.6% yield. And since the dividend payout ratio came in at a modest 43.8% in 2022, there should be plenty of room for the Dividend King to boost its payout to shareholders in the future.
Best of all, J&J stock is trading at a forward price-to-earnings (P/E) ratio of 15.1. This is moderately below the S&P 500 healthcare sector forward P/E ratio of 17.3. And once J&J completes its spin-off of the consumer health segment later this year, there's reason to believe that it could demand a higher valuation multiple moving forward.
2. McKesson: A dominant medical distribution business
McKesson (MCK -0.05%) is a leading healthcare company for wholesale medical supplies and equipment, pharmaceutical distribution, and healthcare technology solutions. Its $49 billion market cap makes it almost as large as its next two competitors combined. The company's 49,000 employees serve customers in 14 countries around the world.
This tremendous size advantage, coupled with significant investments in its supply chain in recent years, is expected to result in above-average earnings growth in the years ahead: Analysts forecast that McKesson will deliver 11.9% annual adjusted diluted EPS growth through the next five years. For context, this is meaningfully better than the 9.6% average annual earnings growth outlook of the medical distribution peer average.
With a 0.6% dividend yield, McKesson is more of a growth stock than a dividend payer. This is reflected in the fact that a $10,000 investment in the stock 10 years ago would now be worth $35,000. That's significantly higher than the $27,000 that an investment in the S&P 500 index would now be worth. This is likely why Berkshire Hathaway owns a stake in the company worth $1.2 billion.
Moving forward, however, investors can expect double-digit annual dividend growth from McKesson due to its low dividend payout ratio and healthy earnings growth forecast. And investors can pick up the stock at a forward P/E ratio of 13.8 -- just above the medical distribution industry average forward P/E ratio of 13.3.
