Warren Buffett and Dividend Income: A Perpetual-Wealth Combination

warren-buffett-annual-meetingI hold something of a minority opinion: I’ve always thought that Warren Buffett should pay dividends to Berkshire Hathaway (NYSE: BRK-B) investors.

Most Buffett watchers, and most Berkshire investors, disagree. They are content to let Buffett reinvest all of Berkshire’s earnings. Given his 50-year investing record, it’s easy to understand why they’d prefer Berkshire earnings be reinvested instead of paid out as dividends. Nevertheless, I’m a dividend guy; I like cash in hand. (For some of the world’s best dividend stocks, click here.)

Buffett also likes cash in hand, so don’t mistake Berkshire’s no-dividend policy as a sign of dividend contempt. Buffett loves dividends, and for good reason: dividend income has been a significant contributor to Berkshire’s long-term success.

Each year, Berkshire receives billions of dollars in dividends from its portfolio holdings. Berkshire’s top five holdings account for 66% of the portfolio’s value. As you can see in the table below, they contribute significantly to Berkshire’s coffers each year.

Berkshire Hathaway Investment Shares Owned Annual Dividends Received
Wells Fargo (NYSE: WFC) 470,292,359 $714.8 Million
Coca-Cola (NYSE: KO) 400,000,000 $528.0 Million
International Business Machines (NYSE: IBM) 79,565,115 $413.7 Million
American Express (NYSE: AXP) 151,610,700 $175.9 Million
Wal-Mart (NYSE: WMT) 60,385,293 $118.4 Million

From these five stocks alone, Berkshire receives more than $1.95 billion in annual dividend income. When you vet Berkshire’s 46 public stock holdings (as of June 30, 2015), you’ll find that nearly all pay dividends.

Buffett not only has a penchant for dividends, he has a penchant for dividend growth. All five of the aforementioned companies are dividend growers. No. 2 on the list – Coca-Cola – serves as an informative example to why Buffett is so partial to dividends in general, and dividend growth in particular.

Berkshire finished accumulating its Coca-Cola stake in 1995. That year, Coca-Cola paid Berkshire $88 million in dividends. Coca-Cola is a perennial dividend grower – the dividend is increased faithfully each year. Fast forward to 2015, and Berkshire is on track to collect $528 million in dividends from Coca-Cola. This is six times the amount collected in 1995.

Twenty years ago, you could have picked up a share of Coca-Cola for around $15.50. This means a 1995 Coca-Cola investor receives an 8.5% yield on his initial investment today. This is more than double Coca-Cola’s current 3.4% yield.

Berkshire is doing a little better, though. Buffett began buying Coca-Cola shares in 1988. Split adjusted, Berkshire’s cost basis on Coca-Cola is estimated to be around $3.25 a share. This means Berkshire earns 41% annually from dividends alone on its Coca-Cola investment. Coca-Cola raises its dividend roughly 7% each year. Within the next 13 years, Berkshire should earn 100% annually on its cost basis.

Now, repeat this investing paradigm with the other top four holdings (and with many of Berkshire’s holdings) and you can appreciate why Berkshire’s value grows over time.

You can also appreciate where Berkshire gets much of its funding for its multi-billion-dollar acquisitions.  Berkshire’s most recent acquisition – Precision Castparts (NYSE: PCP) – will set it back $37.2 billion. But no problem, Berkshire holds $64 billion in cash and cash equivalents. Dividends received over the years have contributed significantly to Berkshire’s M&A kitty.

Investors have a choice: They can invest with Warren Buffett or invest like him. There is a distinction.  When you buy Berkshire Hathaway stock, you invest with Buffett. When you directly buy Berkshire’s portfolio, or buy similar dividend growth stocks, you investment like Buffett.

I prefer the latter scenario – to invest like Buffett –  because I prefer to receive dividends directly. This way, I construct my own perpetual-wealth combination. Either way, though, you’re assured of building wealth over time.

Published by Wyatt Investment Research at