In less than three months, billionaire Warren Buffett's illustrious investing career will come to a close. As stated by the Oracle of Omaha at Berkshire Hathaway's (BRK.A 0.34%) (BRK.B 0.42%) annual shareholder meeting in May, he intends to step down from the CEO role at the end of the year and hand the reins over to predetermined successor Greg Abel.
The reason Berkshire's shareholders (and investors in general) will be sad to see Buffett retire is his track record, which features a nearly 20% annualized return spanning 60 years. He's nearly doubled the average annual return of the S&P 500, including dividends paid.
While extensive books have been written covering the investment traits that have made Warren Buffett so successful, such as his focus on value and long-term approach, the unsung hero to his outperformance might just be dividend stocks.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
In The Power of Dividends: Past, Present, and Future, the researchers at Hartford Funds, in collaboration with Ned Davis Research, compared the average annual return of dividend stocks to non-payers over a 51-year period (1973-2024). What they found was a decisive outperformance for dividend stocks: 9.2% average annual return vs. 4.31% average annual return for non-payers.
Companies that pay a dividend tend to be profitable on a recurring basis, are time-tested, and can provide a transparent long-term growth outlook. In other words, they're just the type of businesses we'd expect to outperform over extended timelines -- and few investors think long-term quite like Warren Buffett.
The Oracle of Omaha's longest-held stocks are generating eye-popping yields on cost
When the Oracle of Omaha buys a stake in a company, it's often with the idea of hanging onto the position for years, if not decades, to come. Out of the nearly four dozen holdings in Berkshire Hathaway's portfolio at present, three stocks have been fixtures for at least a quarter of a century:
- Coca-Cola (KO 1.04%): held since 1988
- American Express (AXP -1.21%): held since 1991
- Moody's (MCO 1.03%): held since 2000
Coca-Cola and American Express (commonly known as "AmEx") are two of the eight existing holdings Buffett referred to as "indefinite" in his 2023 letter to shareholders. Neither he nor his top advisors have any intention of ever selling these stakes. As for credit-rating agency Moody's, it became a holding once it was spun off from Dun & Bradstreet a quarter century ago.
Holding time-tested, brand-name businesses for decades has led to some jaw-dropping low cost bases for Berkshire Hathaway in these industry leaders:
- Coca-Cola: cost basis of $3.25 per share
- American Express: cost basis of $8.49 per share
- Moody's: cost basis of $10.05 per share
Though these three magnificent businesses all have rock-solid dividends with somewhat modest yields, it's a completely different story when comparing their base annual payouts to these aforementioned cost bases. On an annual basis, Berkshire Hathaway's yield on cost is approximately 37% for both Moody's and AmEx, and a mouthwatering 63% with Coca-Cola. This is to say that Berkshire is more than doubling its initial investment in Coca-Cola ($1.3 billion) from dividends alone every two years.
You can see why Warren Buffett and successor Greg Abel should have no desire to ever sell this position.
Image source: Getty Images.
Warren Buffett's secret to abundant dividend income is patience
In a typical year, Berkshire Hathaway collects $5 billion or more in dividend income. This includes the traditional payouts it gets from the likes of Coca-Cola, AmEx, and Moody's, as well as preferred income. The Oracle of Omaha's company holds close to $8.5 billion in preferred stock of Occidental Petroleum that's yielding 8% annually.
Much of this dividend income is the result of Warren Buffett being patient and allowing time to work its magic. For instance, beverage behemoth Coca-Cola has increased its base annual payout for 63 consecutive years, which places it among an elite class of companies known as Dividend Kings (those who've raised their payouts for at least 50 straight years). Holding high-quality stocks for decades and watching their payouts grow over time can be a recipe to net yields on cost of 37% to 63% just like Warren Buffett.
The thing is, Berkshire Hathaway may not be done generating outsize yields relative to its cost basis. Even though Buffett has sold 41% of Berkshire's peak stake in Bank of America (BAC -0.35%), BofA, as the company is better known, has been steadily increasing its payout since the end of the financial crisis. If Abel chooses to hang onto Berkshire's stake in Bank of America over the long run, there's a real chance it could also deliver an eye-popping yield on cost.
In addition to being patient, Berkshire's billionaire boss fancies businesses with sustainable moats. For example, American Express is one of a few major payment facilitators domestically, which is noteworthy since there's a pretty significant barrier to entry in payment processing.
Furthermore, AmEx has a knack for attracting high-earning clientele as cardholders. High earners are less likely than low- and middle-income Americans to adjust their spending habits or fail to pay their bills during a recession. These sustainable competitive advantages help fuel long-term share price (and dividend) appreciation.
Buying high-quality businesses with competitive moats and hanging onto them for decades can be your ticket to eventually netting yields on cost that would make the Oracle of Omaha jealous.
