- We examine five of Buffett's largest dividend holdings, why he might have been attracted to them, and what could happen next.
- Many of Buffett's long-term holdings have been multi-decade winners but are increasingly challenged to continue growing due to the law of large numbers.
- Therefore, while the moats of these companies are still extremely strong, dividend growth prospects are not as impressive. These stocks appear better suited for current income investors.
At the end of June 2015, Warren Buffett owned nearly $120 billion worth of equities and more than 80 businesses. Buffett's investment success is largely derived from his exceptional ability to combine common sense valuation principles with impeccable business judgment. Once he finds a company he believes will continue earning reasonably high returns on capital and reinvesting at similarly high returns, he loads up when the price is reasonable.
Not surprisingly, these types of companies have often withstood the test of time and established difficult-to-replicate market positions for various reasons - brand strength (e.g. Gillette), low cost operations (e.g. Nebraska Furniture Mart), and more.
While Berkshire Hathaway does not pay any dividends, many of Warren Buffett's holdings do. Given the durability of many of Buffett's holdings, they should peak the attention of long-term dividend growth investors. In fact, many of Buffett's dividend stocks are dividend aristocrats. You can view all of Buffett's dividend-paying stocks by clicking here.
Before jumping in, it's important to realize that as Berkshire has grown, the size of its equity investments has had to increase substantially to move the needle.
Depending on the industry, big companies can have greater competitive advantages (they became large for a reason after all) but must combat the law of large numbers when it comes to continued sales and earnings growth. For example, Wal-Mart generates over $60 in sales for every single person in the world - growing sales just 1-2% off of that base is no small feat. For this reason, it is especially important to pay a reasonable price the larger a business is and the lower its long-term growth prospects are.
With that said, let's look at five of Warren Buffett's top dividend stocks.
- KO - Coca-Cola Company (3.4% dividend yield, Forward P/E 19.6)
KO is Buffett's second largest holding, accounting for nearly 15% of his portfolio's total value.
Most people picture Buffett with a Coke in his hand, and he claims to consume about five cans of Coke per day. However, Buffett wasn't always a Coke guy. In his 1962 shareholder letter, Buffett exclaimed that his office "has an ample supply of Pepsi on hand."
I am not sure when Buffett sold PEP, but he started accumulating shares of KO in the late 1980s. Once he was done buying KO, it represented a whopping 25% of Berkshire Hathaway's book value, and it was one of the first big investments where Buffett agreed to pay much higher multiples of earnings and book value than he did with most of his previous investments.
Despite the premium paid, the value of Buffett's investment in KO increased by a factor of 10 over the next decade. KO wasn't a small company at the time Buffett purchased it either, but he had the foresight to understand the brand's global strength and distribution systems, as well as the long tailwind provided by rising soda consumption around the world. He also liked the durability of KO's core product, which remained largely unchanged over decades of time and many different world events. As usual, Buffett would rather be certain of a good result than hopeful of a great one.
Today, the security of KO's future cash flows remains exceptionally high. The company's brand strength, dominant market share, and global distribution systems remain world class, and its balance sheet is exceptionally healthy.
However, future growth prospects have become less certain as syrup volumes have started declining in developed markets and consumers are increasingly health-conscious with what they consume. Rather than play the role of a daily staple, Coke seems at risk of becoming more of a specialty purchase. With soda accounting for well over half of KO's profits, it could prove to be more challenging for the company to cope with this headwind if it accelerates. With a forward P/E of nearly 20 and less certain growth prospects, KO does not make our Top 20 Dividend Stocks list.
With that said, Coke has years, if not decades, of time to adapt to these challenges and opportunities. The company's dividend achieved a 97 Safety Score and 51 Growth Score, reflecting the high quality of the dividend but its more average growth prospects going forward (a score of 50 is average).
You can see our full analysis of KO by clicking here.
- IBM - International Business Machines (3.6% dividend yield, Forward P/E 9.4)
IBM is the third largest position in Buffett's portfolio and represents around 12% of the portfolio.
Buffett started buying IBM in 2011 and added to his position in Q4 2014. IBM trades below where Buffett purchased the stock, but he often prefers his investments to remain low for a period of time, allowing himself and the company to buy more shares at bargain prices. IBM was different than Buffett's other investments in that it was the first technology stock he has ever purchased.
Technology stocks generally need to reinvent themselves more often since the pace of industry change is greater and pricing is typically deflationary. Investments in different technology industries are further complicated by the complexity of the products and services themselves - with innovation happening at such a rapid pace, it can be difficult if not downright impossible for an armchair investor to identify emerging risks to a technology company's cash flows.
Buffett understands all of these issues and more with the technology sector, so his investment in IBM is especially intriguing. Like with many of his investments, Buffett studied IBM for more than 50 years. Through these experiences, he saw first-hand how powerful IBM's brand has been with mega customers such as banks and insurance companies. These customers depend on IBM's mainframes and software to handle and process mission-critical data for things like credit card transactions. With zero tolerance for downtime or security mishaps and programming code dating back decades, it's no wonder IBM has milked the mainframe cash cow for decades.
However, Big Blue has hit a rough patch the last few years as the cloud has started to challenge parts of its business and the company's culture has taken a turn for the worse thanks to excessive cost-cutting in an attempt to meet EPS targets. While the stock looks cheap, we believe a change in management might ultimately be necessary before fundamentals start improving.
For these reasons, we are staying away from the stock but acknowledge it might be of interest to income investors with its 3.6% dividend yield - IBM's dividend received a 93 Safety Score and a 55 Growth Score in our proprietary dividend ranking system.
You can see our full analysis of IBM by clicking here.
- WMT - Wal-Mart Stores (3.1% dividend yield, Forward P/E 14.3)
Buffett's stake in WMT is valued at around $4 billion, good for a little under 4% of his total portfolio and representing his sixth largest position.
Buffett's fascination of WMT could be in part due to his liking of Nebraska Furniture Mart. Buffett often talks about this company and, in addition to his love for the company's owner, the importance of its rock bottom operating costs.
In one of his shareholder letters, he mentions that Nebraska Furniture Mart's operating costs are 15% compared to peers closer to 40%. This allows for huge volume to be generated by underpricing competition, allowing companies to carry the broadest and lowest-priced selection of merchandise available anywhere.
WMT's massive sales base of more than $480 billion (the equivalent of $60+ of sales for every person in the world every year) and its massive distribution network afford it complete domination over the brick-and-mortar discount retail world.
However, given its current size, the rising force of e-commerce, and legitimate labor cost inflation, profitable growth is becoming more of a challenge. WMT's solid cash flows are not going away anytime soon, but earnings growth (and dividend growth) seems more limited going forward to us.
WMT's dividend scored a 94 for safety and a 51 for growth, again suggesting it is more appropriate for dividend investors seeking predictable income rather than long-term dividend growth.
You can see our full analysis of WMT by clicking here.
- PG - Procter & Gamble Company (3.9% dividend yield, Forward P/E 18.3)
Buffett's stake in PG was similar in size to its position in WMT, coming in at about 3.5% of the portfolio's total value. However, he is exchanging most of his stake for Duracell. Still, it is worthwhile to analyze why Buffett held onto PG since it acquired Gillette (the company Buffett originally invested in) and what might have changed.
Right off the bat, PG is attractive because of its simplicity - Bounty, Pampers, Head & Shoulders, Tide, Charmin, Luvs, Cascade, and more are some of the best-known and largest consumer brands. Quite a bit easier to wrap your head around how PG makes money compared to an IBM type of business.
Throughout his shareholder letters, Buffett speaks often about the difference between an "economic franchise" and a business. An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute; and (3) is not subjective to price regulation. Buffett goes on to say that "the existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital."
PG fits the bill almost perfectly. We all have to do laundry, shower, shave, brush our teeth on a daily or weekly basis. These are needs, at least in America. In addition to the generally higher quality of its products, PG has premier shelf space in stores and spends billions of dollars on advertisements each year. These factors have built up trust with customers, and they know they can depend on PG's products to achieve quality results ("thought by its customers to have no close substitute"). Finally, PG's strong brands and relationships with customers have enabled it to consistently raise prices, historically offsetting 50-75% of unfavorable foreign exchange movements. This checks the box for Buffett's third criteria of an economic franchise.
Today, PG is going through some difficult changes. Many of its brands have failed to realize volume growth in recent years, in part due to more competition from private label, volatility in emerging markets, and lack of focus by PG. The company is in the process of shedding over half of its brands (>15% of total sales) to double-down its efforts on its core brands that have been demonstrating better growth and profitability than the overall company today.
We believe PG's underperformance has provided an attractive opportunity for long-term dividend investors. The company's dividend scored 81 for safety and 29 for growth, which is limited in the near-term as management works through the portfolio transition.
You can see our recent analysis of PG by clicking here.
- VZ - Verizon Communications (4.9% dividend yield, Forward P/E 11.7)
VZ is the smallest position of the five mentioned in this article, accounting for around 0.5% of Buffett's total portfolio. However, it is the highest-yielding dividend stock owned by Buffett.
After grumbling about my phone bill, the next thing I think about when it comes to telecom companies is the massive investment it would take to compete with any of them. In order to compete, you would need to spend billions of dollars to acquire rights to wireless spectrum, different radio frequencies that all wireless communications signals travel over the air. The FCC regulates the spectrums that can be used by companies like VZ, which spent over $10 billion the FCC's most recent spectrum auction. In addition to cost, spectrum quantities are rather limited.
The domestic wireless industry is also fairly consolidated, with VZ, T, TMUS, and S controlling over 90% of the market. Less competition provides opportunity for better pricing. The investment needed to build out a reliable wireless network, open thousands of retail stores, and develop a brand as strong as VZ's is easily $10s of billions. Just like Buffett's "insight" about the steadily-increasing demand for KO's syrups over time, the same can be said about data consumption and the need for greater dependency on wireless networks like VZ's. If anything, our need for data services has become even more addicting than a can of Cherry Coke these days.
We also like VZ as a dependable source of current income. Its valuation is certainly reasonable with a 4.9% dividend yield and 12x forward P/E multiple. The stock's dividend scored a 93 for safety and 38 for growth. Long-term dividend growth investors might want to look elsewhere, but this is a good looking dividend stock for retirees or those nearing retirement.
You can see our recent analysis of VZ and T by clicking here.
These five Buffett-owned dividend stocks have some of the most iconic brands in the world and maintain different but equally long-lasting competitive advantages. Most of these companies have enjoyed tremendous growth over many decades and have reached a mature point in their lifecycle - KO, WMT, IBM, and PG are all currently trying to reignite profitable growth with varying degrees of success. This doesn't mean they are bad investments - far from it - but purchasing them at the right price becomes increasingly important the more moderate their growth prospects appear. For that reason, we believe income-seeking investors would do well owning any of these stocks, as most of them have Dividend Safety Scores in excess of 90, meaning their dividends are safer than 90% of all other dividend stocks in the market: KO 97 (3.4% yield), IBM 93 (3.6% yield), WMT 94 (3.1% yield), PG 81 (3.9% yield), VZ 93 (4.9% yield). However, long-term dividend growth investors might want to look elsewhere for faster dividend growth.