Please ensure Javascript is enabled for purposes of website accessibility

Berkshire Hathaway's Bet on Wells Fargo Shows the Power of Dividends

By John Maxfield - Apr 20, 2016 at 1:22PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Wells Fargo's dividend has increased 15-fold since Berkshire Hathaway became the bank's biggest shareholder in 1990.

Image source: iStock/Thinkstock.

If you want a textbook example of the power of dividend stocks, you needn't look any further than Berkshire Hathaway's (BRK.A 0.10%) (BRK.B -0.03%) position in Wells Fargo (WFC -0.79%).

In 1989 and 1990, Berkshire Hathaway paid $290 million for its 10% stake in Wells Fargo. Today, the dividends from that investment alone add up to more than $700 million a year. The shares themselves, meanwhile, are worth more than $23 billion.

Berkshire picked up shares of Wells Fargo for a substantial discount in 1990 due to a severe commercial real estate crisis that was rolling through California at the time, and threatening many of the region's banks. This speaks to the importance of Warren Buffet's maxim to be "greedy when others are fearful and fearful when others are greedy."

Just as importantly, Berkshire's stake in Wells Fargo also speaks to the benefit of investing in well-managed companies that make a habit of increasing their dividends. When the Buffet-led conglomerate bought into Wells Fargo, the bank was distributing the equivalent of only $0.025 per share. That has since grown 15-fold, to $0.375 per share today.

WFC Dividend Chart

WFC Dividend data by YCharts.

There are three things that income investors should factor into their analysis when picking dividend stocks. The first is the dividend yield, which measures how much a company pays out in dividends each year relative to its share price. If a company's stock costs $100 a share, for instance, and it pays out $2.50 a share each year in dividends, then its yield is 2.5%.

A higher yield is better than a lower yield if your objective is to generate income. Yet, a yield that's too high can spell trouble, as yield also reflects risk. One benchmark to use in this regard is the yield on the S&P 500, which is currently 2.2%. As a general rule, yields that are more than twice this figure should be viewed skeptically.

The second metric that should factor into one's decision is the payout ratio. This reflects the percentage of net income a company distributes. Well-run banks like Wells Fargo will pay out roughly a third of their income to shareholders. A payout ratio that's as much as twice as high as this isn't necessarily a bad thing, though it could limit a company's ability to increase its quarterly distribution in the future.

The last metric that should factor into a dividend investor's analysis is the history of dividend increases. The objective here is to identify companies that have a demonstrated commitment to growing their payout consistently. As the chart above shows, for example, absent the temporary disruption to Wells Fargo's dividend during the financial crisis, the nation's third-biggest bank by assets has proven convincingly during the past three decades that it is both willing and able to boost its payout annually.

In sum, while nobody should expect to match the performance of Berkshire Hathaway when it comes to picking stocks, you can benefit similarly from investing in companies that, like Wells Fargo, will pay you substantially larger dividends one or two decades from now than they do today.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Wells Fargo & Company Stock Quote
Wells Fargo & Company
$41.67 (-0.79%) $0.33
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$456,500.00 (0.10%) $468.99
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$304.05 (-0.03%) $0.10

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

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/21/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.