Warren Buffett has arguably been the most prominent face of the U.S. stock market for several decades. That's what happens when your net worth is currently more than the market cap of companies like Starbucks, Goldman Sachs, and AT&T.
It also helps that his company, Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%), has been one of the better stock investments in the past 20 years, far outpacing the S&P 500.
With Buffett's success, it's no wonder people attempt to mimic his moves to try to recreate his success. There are a lot of lessons, both directly and indirectly, to be learned from Buffett and Berkshire, but one of my favorites comes from their Coca-Cola (KO) investment.
You can never go wrong with consistent income
Coca-Cola has been one of Berkshire's most successful and longest-standing investments with the company buying its first shares in 1988. Berkshire now owns 400 million Coca-Cola shares as of June 30. It's the company's fourth-largest holding, accounting for 6.8% of Berkshire's stock portfolio.
There's no doubt Coca-Cola is a great business -- it's one of the quintessential blue chip stocks. You can point to its global distribution, diverse portfolio, and many other factors to show why it's a good investment, but Buffett loves it for one reason in particular: the dividend.
Coca-Cola's current annual dividend is $1.84. That means Berkshire will earn $736 million in dividends from Coca-Cola alone this year. Many corporations around the world don't earn that annually from their operations, and Berkshire earns it in its sleep.
It's not the dividend itself that's the important lesson, though.
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Look for companies that increase their annual dividends each year
It's one thing to offer a high dividend yield. It's a whole different ballgame to offer a payout that's all but guaranteed to increase each year. When Coca-Cola announced its annual dividend increase in Feb. 2023, it was the 61st consecutive year it had done so. Coca-Cola is a certified Dividend King, with only nine companies boasting a longer streak.
Besides the obvious quarterly increase, having a stock that raises its annual dividend each year can work wonders for your total returns over the long haul.
Let's imagine you invest $10,000 into a stock that averages 7% annual returns with a 3% dividend yield over 20 years. Without the dividend, your investment would grow to over $38,600. With it (and assuming you reinvest the dividends), it would be worth over $67,200.
Now, let's imagine you spent the $10,000 and bought 100 shares while the dividend stock was trading at $100. Here's how your investment value would stack up if the company increased its annual dividend by 4% each year.
| Dividend Paid | Dividend Reinvested | Dividend Reinvested and Increased Annually | Investment Value After 20 Years |
|---|---|---|---|
| No | No | No | $38,600 |
| Yes | Yes | No | $67,200 |
| Yes | Yes | Yes | $90,250 |
Source: Author calculations. Rounded to the nearest hundred. Does not include any capital gains owed.
With the annual dividend increase, the investment total increased another 34%. You'll also now own over 220 shares instead of the 100 you originally bought. You can rarely go wrong with accumulating shares over time and then electing to receive your dividends as cash when you retire.
Don't go chasing dividend yields
Since dividend yields increase as stock prices decrease, you don't want to make investment decisions based solely on a company's dividend yield. You want to make sure the stock's payouts are sustainable, or it defeats a lot of the purpose.
One of the most straightforward ways to know if a company's dividend is sustainable is by checking its payout ratio. A company's dividend payout ratio tells you how much of its profit is paid out to shareholders.
What's considered a "good" ratio varies by industry, so it's important to look at similar companies when deciding if a company's payout ratio is sustainable. For example, it's more common for a utility company to pay a dividend than a technology company, so it would make sense if the former had a higher payout ratio.
Coca-Cola's payout ratio is 56%, which is a great mix of being shareholder-friendly and leaving enough profits to ensure the business can continue to make investments and not become stagnant. That's a recipe for longevity.
