There’s nothing wrong with taking ideas from a legendary investor, especially if his first name is Warren. Even investment professionals “steal” ideas from the research of the sell-side, buying up shares in companies after other people’s research points them in the right direction.
Dividend investors would be wise to start stealing ideas from Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.B). Berkshire owns stock in several future dividend rock stars.
Why Berkshire’s portfolio is ripe for picking
Berkshire’s corporate structure gives it a tax discount on dividends. A company that owns 80%-100% of another corporation pays no taxes on dividends received. Smaller holdings provide it a 70% discount the corporate tax rate of 35% on dividends received.
Meanwhile, Berkshire Hathaway Inc. (NYSE:BRK.B) has to pay the full corporate income tax on capital gains. Naturally, dividends taxed at 10.5% are much better than capital gains taxed at 35%.
Buffett ordinarily has a preference for share repurchases because Berkshire Hathaway can increase its position in its top names without paying taxes on the transaction. When The Coca-Cola Company (NYSE:KO) repurchases shares, Berkshire Hathaway would record a capital gain (taxed at the full corporate tax rate, should Berkshire Hathaway Inc. (NYSE:BRK.B) ever sell his position).
Thus, Berkshire’s favorite holding period is “forever.” Berkshire never wants to sell its biggest positions to avoid a 35% capital gain tax rate. Instead, it would prefer to delay those capital gains forever, and eventually collect dividends when it becomes a super majority shareholder in some of the largest firms it owns through the public markets. At a minimum, Berkshire Hathaway Inc. (NYSE:BRK.B) receives a 70% exclusion for dividends paid to Berkshire Hathaway. In effect, Berkshire pays only 10.5% (or less) on dividends received.
Berkshire’s powerful grasp
Warren Buffett is a fan of shareholder-friendly capital allocation. In truth, capital allocation is Berkshire Hathaway Inc. (NYSE:BRK.B)’s business. Whether he owns all or part of a company, smart capital allocation is a necessity. For businesses that want a Buffett premium in their share price, keeping Buffett happy is rule #1.
Here are two companies that pay dividends, and that are perfect for long-term dividend growth investors:
Wells Fargo
One of the biggest mortgage-issuers in the world, Wells Fargo & Co (NYSE:WFC) is a premier retail banking institution. The company has a powerful economic moat in its strong brand and national network of retail branches. Wells Fargo raises capital to make everything from home loans to car loans at rates much lower than the average. The company has a 10-year average cost of deposits of 1.3%, which gives it a competitive advantage in being able to generate a profit at rates well below rates offered by rival banks.
Wells Fargo & Co (NYSE:WFC) also offers excellent capital allocation history. The company used depressed bank values during the financial crisis to swallow up smaller rivals and become one of the largest mortgage lenders in the world.
Since that time, Wells Fargo has also increased its dividends paid to investors after slashing dividends in 2009 to save capital. The company raised its dividend from 5 cents in 2009 to 30 cents per quarter in 2013. Consistent profitability should give it the ability to meet its target payout ratio of 50-60% over the next decade, which on the higher end would lead to a dividend twice as large as its current $.30 quarterly dividend.
At 11 times 2012 earnings and 10 times forward earnings expectations, Wells Fargo & Co (NYSE:WFC) is a company with wide economic moat that understands the idea of proper capital allocation selling at a discount to the broad market. This should make it attractive relative to other dividend-paying companies, which currently trade at earnings-multiple premiums to the market as a whole.
Coca-Cola
The Coca-Cola Company (NYSE:KO) survives and thrives on the back of a high-quality portfolio of non-alcoholic drinks. The company protects itself with its impressive distribution systems, which defend this iconic American brand from new competition.
New innovation and emerging market growth leads Coca-Cola to a future of long-term growth. The company’s Freestyle machines are a major differentiator. Customers can select whatever The Coca-Cola Company (NYSE:KO) product they desire from the machine, mix and match their choices if desired, and select from more than 100 different sodas and soft drinks with a single tap on a touch screen display. The high initial cost of the machine ensures that new users of the freestyle product remain long-term customers of Coca-Cola’s restaurant business.
The Coca-Cola Company (NYSE:KO) has slowly reduced its share count while paying an impressive dividend to investors. It maintains a 50%-60% payout ratio, which has enabled the company to grow dividends paid per share from $0.44 per split-adjusted share to a current quarterly dividend worth $1.12 per year in just the past 10 years.
Latching onto dividend growth stocks
Dividend growth stocks can provide extraordinary value to investors over the long haul. A solid dividend payout ratio combined with well-timed stock repurchases makes for a rapidly increasing net worth for investors and businesses alike.
These two names above, Wells Fargo and The Coca-Cola Company (NYSE:KO), are brands you can stick with for the long haul. Over time, their per-share dividends should grow alongside gradual improvement in earnings per share. That makes for an excellent long-term income machine, as dividends are paid out each quarter and irregular stock repurchases make room for larger dividends per share.
Steal these ideas from Buffett. Over their history, these companies have only paid out more and more of their earnings to owners, making them some of the best-performing stocks in Wall Street history.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway Inc. (NYSE:BRK.B), Coca-Cola, and Wells Fargo. The Motley Fool owns shares of Berkshire Hathaway and Wells Fargo. ordan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Why Dividend Investors Should Steal Buffett’s Stock Picks originally appeared on Fool.com and is written by Jordan Wathen.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
