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Buying Dividend Stocks to Invest Like Warren Buffett

By Andrés Cardenal – Jun 9, 2015 at 10:00AM

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Many Warren Buffett stocks are also among the best dividend stocks in the market, and this is not because of pure chance.

Source: Motley Fool.

Warren Buffett loves dividend stocks. While Berkshire Hathaway (BRK.A -0.67%) (BRK.B -0.87%) does not pay any dividends, many of the largest positions in the company's portfolio are among the most solid dividend stocks on the market, this includes names such as Coca-Cola (KO 0.28%), Wells Fargo (WFC -2.25%), and IBM (IBM 0.17%), among several others.

Warren Buffett loves dividend stocks
Going through Berkshire Hathaway's portfolio, it's easy to identify many of the most prominent dividend stocks across different sectors in the market. Coca-Cola is one of the most iconic Warren Buffett stocks, and the company has an outstanding track record of dividend growth over the long term: Coca-Cola has increased its dividends in each year over the last 52 years, and the stock pays a dividend yield of 3.3% at current prices.

Wells Fargo is Warren Buffett's favorite bank, and also the biggest position in Berkshire Hathaway's portfolio. The company has a simple and low-risk capital allocation policy, which makes it a particularly strong choice for dividend investors looking for sound alternatives in the banking sector.

Wells Fargo had to cut dividends during the financial crisis in 2009, but the company has rapidly compensated investors with growing dividends since then, what was a quarterly payment of $0.05 in 2010 has now turned to 0.375 quarterly, and Wells Fargo is currently paying a 2.7% dividend yield.

Warren Buffett typically stays away from companies in the tech business, but he made a notable exception with IBM. Buffett first invested in Big Blue in 2011, and he has been adding to the position in recent quarters. Due to its brand presence and established relationships with major corporate customers across the world, IBM is a particularly solid play in the tech industry, and management has translated the company's strengths into growing dividends for investors over the long term.

IBM has paid uninterrupted dividends since 1916, and it has increased payments over the last 20 consecutive years. Dividends have doubled in the last five years, and this includes a generous dividend hike of 18% for 2015. After the latest increase, IBM is paying a dividend yield of 3%.

On dividends and competitive strengths
Dividends can say a lot about the health of a business. In order to distribute consistently growing cash flows to investors, a company has to generate more cash than in needs to reinvest in its operations over time.

This means that companies with outstanding dividend growth are usually those with enough soundness to successfully go through the ups and downs of the business cycle, and they also have the competitive strengths to protect their sales and cash flows from the competition. With this in mind, it's no wonder why many Warren Buffett stocks are also outstanding dividend payers.

Berkshire Hathaway is a notable exception to the rule, as the company pays no dividends whatsoever. However, this is related to Berkshire's business model and the amazing investing talent of Warren Buffett. Berkshire is in the business of capital allocation, the company generates far more cash than it needs to reinvest in its operations, but Warren Buffett retains that cash in order to allocate it to different investment opportunities.

For a company like Coca-Cola, or most other businesses in the world for that matter, the right thing to do with excess cash flows is distributing that money to investors. However, investors in Berkshire Hathaway are better served by leaving that money in Buffett's hands, so the Oracle of Omaha can put it to work and obtain superior returns over time. Berkshire doesn't pay any dividends, but that's only because Buffett can put that money to better use, not because the business does not generate enough cash to make dividend distributions.

Dividends convey important information about a company's fundamental strengths, and Warren Buffett is all about investing in top-quality businesses with undisputed soundness. With this in mind, going for companies with a solid track record of dividend growth could be a smart way to follow Warren Buffett's guidelines when making investment decisions.

Andrés Cardenal owns shares of Apple, Berkshire Hathaway, and International Business Machines. The Motley Fool recommends Apple, Berkshire Hathaway, Coca-Cola, and Wells Fargo. The Motley Fool owns shares of Apple, Berkshire Hathaway, International Business Machines, and Wells Fargo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

International Business Machines Stock Quote
International Business Machines
$149.16 (0.17%) $0.26
Coca-Cola Stock Quote
$63.79 (0.28%) $0.18
Wells Fargo & Stock Quote
Wells Fargo &
$46.87 (-2.25%) $-1.08
Berkshire Hathaway Stock Quote
Berkshire Hathaway
$477,085.00 (-0.67%) $-3,195.00
Berkshire Hathaway Stock Quote
Berkshire Hathaway
$315.84 (-0.87%) $-2.76
Apple Stock Quote
$148.31 (0.19%) $0.28

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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