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Any Buffett follower likely knows that Berkshire Hathaway’s (BRK.A) largest equity holding is Coca-Cola (KO). They probably know the reasoning as well: Coca-Cola has a wide and tangible economic moat that has both the ability and allure to hand out 1.7 Billion servings a day.

KO has long been the knock-out, hands down pick as the world-wide beverage provider. True PepsiCo (PEP) is a strong second, but it’s becoming more of a snack monopoly than it is a beverage contender. As Buffett once said about Coca-Cola, when the now $158 Billion Market-Cap was closer to $100 Billion: “If you gave me $100 Billion and said, ‘Take away the soft-drink leadership of Coca-Cola in the world’, I’d give it back to you and say it can’t be done”.

For the dividend growth investor, KO has been one of the most consistent and rewarding payout plays out there. Not only has Coca-Cola paid a dividend for the last 49 years, it has also increased it. During the last decade these annual payment boosts have come in at an average yearly rate around 10%, suggesting that your yield on cost would double in about 7 years. With more profits to be made and a payout ratio under 40%, I see no obstacles in the way of KO’s 50th consecutive dividend increase. Look for the golden anniversary announcement this February.

Given such a stable and growing dividend many would advocate initiating a DRIP, or Dividend Reinvestment Plan, on Coca-Cola stock. After-all, it makes sense as a ‘set-it and forget’ type of continual investment for a company you believe in. Buffett himself makes has no qualms about professing his affection for KO nor his 5 Cherry Cokes a day, yet Berkshire Hathaway has made no attempt to purchase additional Coca-Cola stock since 1996. KO has increase in value 10 times over since his original purchase and still, not once in the last 15 years has the Oracle of Omaha had the desire to add another share of Coke to his portfolio.

Last year Coca-Cola paid out an annual dividend of $1.88. For Berkshire Hathaway’s 200 million shares, that means Buffett collected a nice set of checks valued at $378 million. This translates to more than a million dollars a day before taxes; that’s almost $12 a second.

Here’s a look at the last 15 years of KO dividend checks sent to Berkshire Hathaway:

Year

Shares Owned

Yearly Dividend

Payout (In $ Millions)

1997

200,000,000

$0.56

$112

1998

"

$0.60

$120

1999

"

$0.64

$128

2000

"

$0.68

$136

2001

"

$0.72

$144

2002

"

$0.80

$160

2003

"

$0.88

$176

2004

"

$1.00

$200

2005

"

$1.12

$224

2006

"

$1.24

$248

2007

"

$1.36

$272

2008

"

$1.52

$304

2009

"

$1.64

$328

2010

"

$1.76

$352

2011

"

$1.88

$376

Total Payouts

$3.280 Billion

% of KO Owned =

2012 Price

$13.994 Billion

8.81%

From 1997 to 2011, Coca-Cola was able to increase its annual dividend from $0.56 a share to $1.88, as of last month. This represents an average yearly dividend growth rate of about 9%, well ahead of inflation and in line with many dividend growth investors' expectations. For Buffett, along with the KO stock price appreciation ten times over, that also means a whooping 29% yield on his original cost basis. For those in the DRIP camp, you must be clamoring “Imagine if dividends were reinvested!” Well, you don’t have to imagine, you can just look below:

Year

Shares Owned

Yearly Dividend

Payout

Highest Share Price

Additional Shares

1997

200,000,000

$0.56

$112,000,000

$72.62

1,542,275

1998

201,542,275

$0.60

$120,925,365

$88.94

1,359,629

1999

202,901,903

$0.64

$129,857,218

$70.87

1,832,330

2000

204,734,233

$0.68

$139,219,279

$66.87

2,081,939

2001

206,816,173

$0.72

$148,907,644

$62.19

2,394,399

2002

209,210,571

$0.80

$167,368,457

$57.91

2,890,148

2003

212,100,719

$0.88

$186,648,633

$50.90

3,666,967

2004

215,767,686

$1.00

$215,767,686

$53.50

4,033,041

2005

219,800,727

$1.12

$246,176,814

$45.26

5,439,170

2006

225,239,897

$1.24

$279,297,472

$49.35

5,659,523

2007

230,899,420

$1.36

$314,023,211

$64.32

4,882,202

2008

235,781,621

$1.52

$358,388,065

$65.59

5,464,066

2009

241,245,687

$1.64

$395,642,927

$59.45

6,655,053

2010

247,900,740

$1.76

$436,305,303

$65.88

6,622,728

2011

254,523,468

$1.88

$478,504,120

$71.77

6,667,189

2012

261,190,657

Total Payouts

$3.729 Billion

% of KO Owned

2012 Price

$18.275 Billion

11.50%

I used the highest monthly share price for a variety of reasons. Namely, I did not care to take into account taxes, transaction costs or a potential run-up in price due to the large quantity of additional shares purchased. It is likely that additional shares would be purchased at a lower price, even when considering the aforementioned extraneous factors. Incidentally, if you redo the calculations using the lowest monthly price, you find a value of $3.931 Billion in dividend payouts versus $3.729 Billion, a price today of $20.213 Billion versus $18.275 Billion using the highest monthly share prices and an ownership stake of 12.73% versus 11.5%. If Buffett actually reinvested KO dividends, the numbers would likely fall somewhere in-between the two.

Here’s the point. Over the last 15 years, Buffett had the opportunity to increase his stake in Coca-Cola from 8.81% to 11.50% today. He could do this without using a single dime of new capital, yet he declined to do so. It’s not that he was looking to diversify, or he simply forgot about his beloved Cherry Coke. As Berkshire’s 1994 shareholder letter states: “Before looking at new investments, we consider adding to old ones. If a business is attractive enough to buy once, it may well pay to repeat the process.” So what gives?

One need not look further than Buffett’s mentor, Benjamin Graham and his “Price is Paramount” rule of thumb, for an answer. Sure, Warren could have reinvested the Coca-Cola dividends and be sitting atop a larger stake of KO right now. But it isn’t as if the alternative to reinvesting payouts is sitting on cash. If Berkshire felt that there weren’t any viable alternatives that were better than Coca-Cola, at a given price, then I am sure Buffett would have been reinvesting dividends. More than that, new capital would have been deployed. This didn’t happen, and instead Buffett used the KO dividends-- along with a colossal assortment of other operating profit-- to find more attractive investments.

While dividend growth investors are unlikely to take a gander at Berkshire Hathaway’s ‘zero-yield-not-going-to-happen’ dividend, they could do well following Buffett’s strategy. Warren finds attractive companies with wide economic moats, waits for them to make money, and then redeploys this capital into similar-- albeit more attractive-- investments. Here is just a sampling of dividend-companies Buffett was able to invest in by using the profits from other companies.

American Express (AXP) – Pays Berkshire $300,000 a day in dividends. 1.5% current yield. Payout ratio of 18%.

Wal-Mart (WMT) – Pays Berkshire $6,500 an hour in dividends. Has increased payouts for 37 straight years. Likely increase announcement this March. 2.4% current yield.

ConocoPhillips (COP) – Paid Berkshire nearly $77 Million in dividends last year. The Upcoming Split could be an opportunity to buy. 3.6% current yield.

Johnson & Johnson (JNJ) – Pays Berkshire nearly $2 million a week in dividends. Has increased payouts for the last 49 years. 3.5% current yield.

Procter & Gamble (PG) – Pays Berkshire more than $12.5 million a month in dividends. Has increased payouts for 55 years. Current yield = 3.1%

Kraft (KFT) – Pays Berkshire about $215 a minute in dividends. 63% payout ratio. 3.1% current yield.

IBM (IBM) – Newest Dividend Growth stake. Will pay Berkshire nearly $50 million a quarter in dividends. Has Increased payouts for 16 straight years. Current yield = 1.6%.

All in all, just these 7 companies plus the stake in Coca-Cola will pay Berkshire almost $1.2 Billion in dividends next year. Additionally, that number will likely be much higher as WMT, COP, JNJ, PG, IBM and KO all appear poised to announce dividend increases this year. In the same manner, these capital additions will look to find new, more attractive opportunities.

Buffett also detailed in that 1994 letter this bit of wisdom: “It’s far better to own a significant portion of the Hope diamond than 100% of a rhinestone”. But this doesn’t mean you have to put all of your eggs in one basket, even if it’s by far the best basket in town. There are plenty of strong, fundamental businesses that Mr. Market is willing to mis-price for you.

For the individual dividend growth investor, especially those just starting out or initiating new positions, the DRIP method is perfectly reasonable. It would even be unwise, for example, if one were to receive a $25 dividend check to look for the most attractive alternative. Transaction costs would eat you alive. With small sums, DRIP makes perfect sense. But once you reach a level whereby you can make investments without sacrificing from transaction costs, it could be the opportunity to stop the DRIP and pour into companies you feel are a better buy.

Source: Why Warren Buffett Doesn't Own 11.5% Of The Coca-Cola Company