Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) CEO Warren Buffett has been captivating Wall Street's attention for more than a half-century.
Since taking control at Berkshire Hathaway in 1965, Buffett has overseen an aggregate gain in his company's Class A shares (BRK.A) of better than 4,400,000%, as well as doubled up the annualized total return, including dividends, of the benchmark S&P 500 (19.8% vs. 9.9%, as of Dec. 31, 2022). Gains of this magnitude will get you noticed by professional and everyday investors.
The Oracle of Omaha's formula for success is lengthy, but he's been more than willing to share what he looks for in his investments. When boiled down to the basics, Buffett is a big fan of profitable, time-tested, brand-name businesses, with strong management teams. He also favors concentrating a meaningful percentage of Berkshire Hathaway's $358 billion investment portfolio into a couple of top ideas.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
Dividend stocks are the unsung hero of Berkshire Hathaway's investment portfolio
But the unsung hero of Buffett's success just might be dividend stocks. Berkshire Hathaway is on pace to collect more than $6 billion in dividend income over the next 12 months.
Historically, income stocks have handily outperformed publicly traded companies that don't offer a dividend. A study published 10 years ago by the wealth management division of JPMorgan Chase found that companies initiating and paying a dividend generated an annualized return of 9.5% between 1972 and 2012. Meanwhile, the non-payers produced an annualized return of just 1.6% over the same 40-year timeline.
Berkshire Hathaway's portfolio has stakes in a number of big-time dividend stocks, including energy company Chevron (CVX 0.37%), healthcare conglomerate Johnson & Johnson (JNJ -0.46%), and money-center bank Citigroup (C 1.41%).
Oil stocks are known for returning a lot of capital to their shareholders via dividends and buybacks. Earlier this year, Chevron's board OK'd an up to $75 billion share repurchase program and lifted the company's payout for a 36th consecutive year. Chevron continues to benefit from tight global oil supply that's the result of pandemic-related underinvestment and Russia's ongoing war with Ukraine.
Although it's a relatively small position for Berkshire Hathaway, Johnson & Johnson has increased its base annual payout for 61 consecutive years. Only a small handful of publicly traded companies can boast of a longer streak of annual dividend increases. J&J steadily shifting more of its net sales to high-margin, faster-growing pharmaceuticals has helped fuel these dividend hikes.
There's also Citigroup, which boasts the highest nominal yield in Warren Buffett's portfolio -- 5.1%, as of the closing bell on Sept. 7, 2023. Bank stocks like Citi are benefiting from the Fed's most-aggressive rate-hiking cycle in four decades, which is boosting their net-interest income on outstanding variable-rate loans. The Oracle of Omaha has always been a big fan of buying stocks that can take advantage of the natural expansion of the U.S. economy.
Image source: Getty Images.
This Buffett holding offers more than 11 times the yield of Citigroup
However, nominal yield only tells part of the story. Because Warren Buffett and his investment team have a tendency to hold the stocks they buy for years, or even decades, the yield Buffett's company generates relative to Berkshire Hathaway's cost basis can be significantly higher for longtime holdings.
Don't get me wrong, a 5.1% yield from Citigroup is more than three times higher than the average yield you'll get from an S&P 500 tracking index. But there's one Buffett stock that offers a yield to cost that's over 11 times greater than Citi's nominal yield.
In 1988, Warren Buffett began building Berkshire Hathaway's stake in beverage stock Coca-Cola (KO). As of June 30, 2023, Buffett's company held 400,000,000 shares of Coke stock, with a cost basis of $3.2475. The thing is, Coca-Cola has matched Johnson & Johnson by raising its base annual payout for 61 consecutive years. Based on the $1.84/share Coca-Cola is expected to pay its shareholders over the next 12 months, Berkshire is in line to generate a 56.7% yield relative to its cost basis ($1.84 divided into the $3.2475 cost basis).
Coca-Cola's long-term outperformance and sustained dividend growth is due to a combination of its branding, untapped markets, and top-tier marketing team.
In terms of the former, Coke is viewed as one of the most-recognized and valuable brands in the world. The company has operations in all but three countries (Russia, Cuba, and North Korea), and it's consistently been highlighted by Kantar as the "most chosen brand on the planet" in its annually released Brand Footprint report.
Though Coke's growth rate is modest compared to 30 or 40 years ago, it still possesses plenty of potential beyond the borders of the United States. While developed markets represent the company's bread-and-butter in terms of predictable cash flow, emerging markets are where Coca-Cola can truly lift its organic growth rate. The company already has 26 brands generating more than $1 billion in annual sales. Overseas markets should help grow this figure even more.
Perhaps Coca-Cola's greatest asset is its marketing. It's currently spending more than half of its advertising budget on digital initiatives, which includes leaning on artificial intelligence (AI) to craft ads for a younger generation of consumers. However, it also has well-known brand ambassadors and holiday tie-ins that allow it to connect with a more mature audience. Few businesses can transcend generational gaps quite like Coca-Cola.
With Berkshire Hathaway more than doubling its initial investment in Coca-Cola every two years thanks to a nearly 57% yield on cost, there's absolutely no incentive for Buffett or his team to ever dispose of this core position.
