As this past weekend demonstrated, few if any money managers can captivate the attention of investors quite like Berkshire Hathaway (BRK.A 0.64%) (BRK.B 0.54%) CEO Warren Buffett. Since taking over as CEO of Berkshire Hathaway in the mid-1960s, Buffett has overseen a 3,787,464% return on his company's Class A shares (BRK.A). That's 153 times the total return, including dividends, of the benchmark S&P 500 over the same span. It takes more than luck to lap the performance of the S&P 500 by a factor of 153.
Buffett's recipe for success is extensive, but the Oracle of Omaha is more than willing to share the "tricks" he's used to grow his wealth and that of his shareholders. These catalysts include approaching investments with a long-term mindset, gravitating to cyclical businesses, concentrating Berkshire Hathaway's investment portfolio, and putting money to work in brand-name companies with trusted management teams.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
Dividend stocks are Berkshire Hathaway's unsung hero
But if there's a reason for Buffett's success that doesn't get nearly enough attention, it's his love of dividend stocks.
Publicly traded companies that regularly pay a dividend are almost always time-tested, profitable on a recurring basis, and offer transparent growth outlooks. Income stocks also have a knack for long-term outperformance and consistently outpace stocks that don't offer a payout.
A majority of the roughly four dozen securities held in Berkshire Hathaway's $335 billion investment portfolio pays a dividend. As of March 31, 2023, I calculated that Buffett's company was on pace to collect almost $6.14 billion in dividend income this year.
However, thanks to portfolio concentration, a small percentage of Berkshire Hathaway's holdings will account for a sizable share of this dividend income. Two stocks that the Oracle of Omaha and his investing lieutenants, Todd Combs and Ted Weschler, have been loading up on in recent years are expected to account for nearly $2 billion in annual dividend income.
Two recent buys will account for close to $2 billion in annual dividend income
Interestingly enough, Berkshire Hathaway's two largest holdings -- tech stock Apple (AAPL -0.57%) and bank stock Bank of America (BAC 1.53%) -- aren't the top dividend producers. Although Apple and BofA collectively account for 53.6% of invested assets and will generate an estimated $878.9 million and $908.9 million in respective dividend income this year, the annual income they produce still trails two other holdings.
The two "ATMs" of Warren Buffett's portfolio are energy stocks Chevron (CVX 0.75%) and Occidental Petroleum (OXY 0.09%). Chevron has been a continuous holding since the fourth quarter of 2020, while Berkshire's Occidental Petroleum stake has been steadily growing since the first quarter of 2022.
Including shares held by Warren Buffett's secret portfolio, New England Asset Management, Chevron should bring in about $1.01 billion in annual dividend income. Oil stocks are known for their robust capital-return programs and Chevron is no slouch. It's increased its base annual dividend for 36 consecutive years.
Meanwhile, Occidental Petroleum is expected to bring in $952.4 million in annual dividend income. The roughly 211.7 million shares of common stock Berkshire owns should produce $152.4 million of this annual payout. The remaining $800 million will come from a $10 billion preferred stock position yielding 8% that Warren Buffett's company has owned since 2019. Occidental used this $10 billion investment to help fund its acquisition of Anadarko.
Collectively, Chevron and Occidental will generate 32% of Berkshire Hathaway's annual dividend income.
Image source: Getty Images.
Here's why Buffett and his team are gushing over Chevron and Occidental Petroleum
In just a few years, energy stocks went from being virtually nonexistent to representing the third-highest weighting by sector in Berkshire Hathaway's portfolio. Make no mistake, Buffett and his team wouldn't have piled the amount of money they did into Chevron and Occidental if they didn't firmly believe that energy commodity prices (specifically oil) would remain elevated. Two macro catalysts support this thesis.
Probably the most obvious catalyst for higher energy commodity prices is Russia's invasion of Ukraine last year. The war between Russia and Ukraine has no clear end date, which puts European oil and gas supply needs into question.
What's arguably the bigger issue is that global energy majors have pared back their capital investments for three years due to the COVID-19 pandemic. Even though we appear to be putting the worst of the pandemic into the rearview mirror, making up for an extended period of reduced capital expenditures will take years. Generally, an environment where oil and/or gas supply is constrained tends to bode well for energy stocks.
Something else to consider is that Chevron and Occidental Petroleum are both integrated operators. Although their best operating margin derives from their upstream drilling segments, Chevron and Occidental also have chemical businesses. Chevron operates transmission pipelines and refineries as well. In the event that the price of crude oil declines, these ancillary operations can partially hedge any weakness from upstream operations.
Another reason Buffett and his team are likely gushing over energy stocks is their improving balance sheets. Chevron closed out 2021 with $25.7 billion in net debt. Thanks to higher energy commodity prices, it's been able to reduce its net debt to just $7.4 billion, as of March 31, 2023. Comparatively, Occidental Petroleum's net long-term debt has fallen from $35.5 billion at the end of March 2021 to $19.7 billion by the close of 2022. Having more flexible balance sheets means both companies can increase their respective share buyback programs.
For the Oracle of Omaha, "big oil" means big dividends.
