Buffett's a Dividend Investor, Why Aren't You?

Follow the Oracle's lead here.

James Royal
Jim Royal
May 27, 2010 at 12:00AM
Other

One of the worst misconceptions about dividend investing is that it's boring. If you mean regularly increasing gobs of cash delivered to your brokerage account, then OK, it's boring. Heck, some even think dividends are dumb.

But for those of us who love it when someone deposits money into our accounts, it's the most powerful and low-risk form of investing around, I would argue. And I have.

In fact, dividend investing is so powerful that the world's greatest investor, Warren Buffett, has made it a staple of his portfolio, a good reason that you should too.

Buffett, a dividend investor?!
Sure, Buffett is known primarily as a value investor, but the Oracle of Omaha has made a career of finding businesses that pump out cash like oil from a well, a trait that makes them primed to be outstanding income stocks. Such cash-flow companies include high-quality insurers like GEICO or other well-run financials such as Wells Fargo and American Express.

One of Buffett's finest picks has been a dividend monster. The stock? Coca-Cola (NYSE: KO). Buffett first started acquiring Coca-Cola shares in 1988 and has built a position of 200 million shares as of March 2010, meaning he owns nearly 9% of the soda king. Coca-Cola forms 21% of Berkshire's investment portfolio, followed by Wells Fargo at 18%.

But in 1988 Coca-Cola wasn't the clear slam-dunk choice it appears today. Buffett was one of the first investors to see its enviable Coke brand as a serious competitive advantage. The superinvestor has now held shares for over 20 years and has repeatedly praised the efficiency of its capital-light business model, which spits out tons of free cash.

That free cash has allowed the company to consistently raise its dividend, making a small fortune for a long-term holder like Buffett.

Because Coca-Cola has raised its dividend by 12% on average over the last 21 years, Buffett now manages to get back about one-third of his original investment every year. If the company continues to increase its dividend at this historical rate, in about nine years Buffett will manage to get back his original investment in dividends every year!

Given Coca-Cola's steady economic performance and solid record of increasing dividends, there's every indication that it will continue those growing payouts. That's the power and excitement of income investing with a rock-solid company: increasing payouts for life.

And that's not all ...
As Buffett did with Coca-Cola, when screening for dividend stocks you should look for strong fundamentals such as steady profitability and increasing growth over time.

Generally, you should avoid cyclical companies, since they may be unable to maintain consistent profitability, which could endanger their ability to pay a dividend. Instead, focus on businesses whose products will be in demand regardless of the financial climate, helping to ensure a steady payout.

Here are a few that fit my criteria.

Company

Trailing Dividend Yield

5-Year Dividend Growth Rate

5-Year Earnings Growth

Procter & Gamble (NYSE: PG)

3.2%

11.9%

13.5%

McDonald's (NYSE: MCD)

3.2%

30.7%

13.3%

Microsoft (Nasdaq: MSFT)

2%

16.7%

9%

Johnson & Johnson (NYSE: JNJ)

3.6%

11.4%

8.5%

General Mills (NYSE: GIS)

2.7%

9.1%

9.7%

Nike (NYSE: NKE)

1.5%

18.2%

8.1%

Source: Capital IQ, as of May 27, 2010.

Each of these companies has a remarkably strong franchise for consumer products that we use day in and day out, as you can see in their consistent earnings growth.

While Procter & Gamble offers the detergents and shaving products we use on a daily basis, McDonald's offers the most known fast-food brand along with its famous fries. It's hard to operate a computer without using Microsoft software somewhere, and Johnson & Johnson's health products cover a wide swath, from mundane goods such as Band-Aids and Tylenol to ultra-high-tech medical devices. General Mills profitably serves up its cereals, as well as yogurt and pizzas -- in short, some of the popular foods in the grocery. And Nike is so ubiquitous that it's hard to imagine sports without this brand.

The indispensability of their products ensures that payouts from such blue chips can grow for decades, turning even a small initial investment into a dividend dynamo, just like Buffett did with Coke.

Follow these dividend stars
Like Buffett, the experts at Motley Fool Income Investor are focused on "boring" companies that mint money -- including Coca-Cola. Advisor James Early and the whole Income Investor team look for companies offering a yield of 3% or better and that are primed to increase their payouts for the long term.

If you want more dividend stocks that could help give you an easy retirement, regardless of the ups and downs of the stock market, click here to join Income Investor as our free guest for 30 days. James can help point you to the handful of the thousands of public companies that can secure you an income for life.

Jim Royal, Ph.D. owns shares in Procter & Gamble and Microsoft. American Express, Coca-Cola, and Microsoft are Inside Value selections. Johnson & Johnson, Coca-Cola, and Procter & Gamble are Income Investor recommendations. Motley Fool Options has recommended a buy calls position on Johnson & Johnson and a diagonal call position on Microsoft. The Fool owns shares of Coca-Cola and Procter & Gamble. The Fool has a disclosure policy.