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Since 1965, Berkshire Hathaway has recorded an average annual return of 20% for its shareholders. This means that investors have seen their shares double in value, on average, every 3.6 years since 1965. Between 1964 and 2020, Berkshire’s shares have outperformed the benchmark S&P 500, including dividends, by a total of almost 2,800,000% (yes you read that right).
Buffett’s success has mainly been attributed to his identification of companies with sustainable competitive advantages, as well as his willingness to hold his investments for long periods of time.
But what is often overlooked in Oracle of Omaha’s success story is the role that dividend stocks have played. Companies that pay a dividend have historically run circles around stocks that do not pay dividends over the long term. Moreover, companies that pay a regular dividend are generally profitable and have proven operating models, which is exactly what Buffett looks for in a company. By holding long-term successful dividend stocks, Buffett has been able to achieve a consistently higher dividend yield than Berkshire Hathaway’s cost base.
Taking into account Berkshire’s fourth-quarter 2020 investment activity, as well as its preferred shareholding in Occidental Petroleum, Buffett’s company is set to generate more than $5 billion in dividend income in 2021. Based on an initial cost base of $108.6 billion, this works out to a nearly 5% return on costs.
However, for some of the holdings held by Buffett, a 5% return on costs would be peanuts. Buffett’s patience with the following three stocks has resulted in an annual return of 20% to 52%, based on Berkshire Hathaway’s initial costs.
Beverage giant Coca-Cola (NYSE: KO) is one of the oldest stocks within Berkshire’s investment portfolio. The 400 million shares Berkshire owns have a cost basis of $1.299 billion, which equates to $3.2475 per share. With Coca-Cola increasing its annual base dividend for the 59th consecutive year in February to $1.68, Buffett and his team will reap a 52% yield in 2021. That’s not too paltry a yield to be patient and let your investment thesis run its course.
What makes Coca-Cola such a special stock to own is its combination of geographic reach and superior marketing. In terms of reach, Coca-Cola operates in all but two countries in the world: North Korea and Cuba. It has 20 per cent of the cold drinks market share in developed markets, holds 10 per cent of the cold drinks share in fast-growing emerging markets and has at least 20 brands in its portfolio that generate $1 billion or more in annual sales.
Coca-Cola will never let Wall Street down with its growth rate, but it is unlikely that Coca-Cola will be sold as long as Buffett is in charge of Berkshire Hathaway’s investment portfolio.
Another stellar dividend stock for Buffett, and perhaps one of his biggest investments of all time, is credit rating agency Moody’s (NYSE: MCO). Berkshire Hathaway has owned shares in Moody’s since its spinoff from Dun & Bradstreet in 2000. With an initial cost basis of $10.05 and an annual base payment of $2.48, Moody’s earns Buffett and his team about 25% per year!
At the moment, things couldn’t be better for Moody’s. Historically low lending rates are encouraging companies to issue debt at a rapid pace, which has kept Moody’s credit rating operations busy. Even with an expected slowdown in debt issuance in 2021, the segment should still generate sales and profits above the historical norm.
Meanwhile, stock market volatility has played a role in strengthening the firm’s analytical segment. Companies rely on Moody’s to help mitigate both domestic and international risks, with banks relying on Moody’s to maintain compliance with evolving liquidity rules and regulations.
As with Coca-Cola, we’re not talking about a company whose growth will make Wall Street cheer, but with its fingers in so many facets of the financial services industry, it really is in good shape to benefit no matter what happens to the US economy in the short term.
Buffett is also banking from financial services company American Express (NYSE: AXP), which has been a continuous holding in Berkshire’s portfolio since 1993. Purchased with a cost basis of $8.49, but paying $1.72 per year, American Express is on track to deliver a 20% annual return to Buffett’s company in 2021.
The beauty of American Express’ operating model is that it’s a numbers game that long-term investors are almost certain to win. This is to say that AmEx, like other payment processors and lenders, feels the pain when recessions hit, but basks in higher spending levels during periods of economic expansion. The fact is that recessions are often measured in months, while economic expansions last for years, or perhaps even more than a decade.
American Express also has a knack for attracting affluent customers. Gold cardholders are less likely to change their spending habits during tough economic times. These affluent customers and the fees they pay play an important role in boosting the company’s profits.
As with Coca-Cola, Buffett has no reason to ever part with his American Express stock.