If ever there was a ringing endorsement for dividend investing, it recently arrived courtesy of Warren Buffett in the latest edition of Berkshire Hathaway’s annual shareholder letter.
In that always widely anticipated missive, Buffett referred to dividends as Berkshire’s “secret sauce,” highlight two examples of the potency of the conglomerates investments in companies with enviable track records of payout growth – Dow components American Express (NYSE: AXP) and Coca-Cola (NYSE: KO).
In the case of Coca-Cola, Berkshire bought $1.3 billion of the stock in 1994, receiving an annual dividend at that time of $75 million. By last year, that payout ballooned to $704 million. It’s comparable, equally as impressive story with American Express.
“American Express is much the same story. Berkshire’s purchases of Amex were essentially completed in 1995 and, coincidentally, also cost $1.3 billion. Annual dividends received from this investment have grown from $41 million to $302 million. Those checks, too, seem highly likely to increase,” opined Buffett.
Point is, if dividends are a centerpiece of Buffett’s investment philosophy, this style of investing is more than relevant for everyday clients and investors.
Proof Is in Dividend Pudding
Obviously, some clients, likely those in retirement or nearing it, need income and don’t have the luxury of dividend reinvestment at substantial levels. However, advisors should articulate the advantages of dividend reinvestment to clients that have time on their side.
“Generally, increasing stock prices are the way most equity investors think money is made. But dividends play an important role as well,” notes Morningstar analyst Daniel Noonan. “Since 1993, the S&P 500 increased by 777% through the end of last year. With dividends included, the S&P 500 increased by more than 1,400% during the same period.”
Over that period, dividends account for 20% of the S&P 500 total returns – just half the average seen from 1930 through 2021. However, that doesn’t diminish the importance of dividends. If anything, those statistics cement the importance of quality dividends and not simply focusing on big yields. Intel’s (NASDAQ: INTC) recent payout cut is a reminder of the risks of investing based on yield.
“When seeking out dividend-paying companies, it’s important to identify whether the dividend being paid will be consistent with opportunities to increase it over time, like Coke and American Express,” adds Noonan.
Wide moat companies, which are also favorites of Buffett, aren’t always dividend payers. Many aren’t, but many are, indicating there is something of an intersection between deep competitive advantages and robust payouts. American Express and Coca-Cola are examples of that theme.
Cost advantages, efficiency of scale, intangible assets, network effects and switching costs are the hallmarks of companies with the wide moat designation.
“A network effect occurs when the value of a company’s service increases for both new and existing users as more people use the service. For example, the more consumers who use American Express credit cards, the more attractive that payment network becomes for merchants. This in turn makes it more attractive for consumers, and so on,” concludes Noonan.
The point: There are benefits beyond income that make dividends worth embracing.