The investment approach of Warren Buffett has consistently demonstrated effectiveness over many years. He seeks out firms that offer robust and increasing dividends. In his latest correspondence to Berkshire Hathaway investors, Buffett disclosed his “secret ingredient” for achieving success.
He pointed out two specific stocks: Coca-Cola and American Express. Buffett purchased his final share of Coca-Cola in 1994, a year during which he earned $75 million in dividends from that investment.
By 2022, the yearly dividends had surged to $704 million. Coca-Cola has increased its dividend on two occasions within the last two years. Berkshire Hathaway finalized its acquisition of American Express shares in 1995.
They allocated the same capital as they did for Coca-Cola: $1.3 billion. In 1995, American Express paid Berkshire $41 million as dividends. By 2022, this recurring dividend revenue had escalated to $302 million annually.
Last spring, American Express declared a dividend enhancement of 17%.
Buffett’s strategy for dividend growth
Currently, Berkshire’s yearly income from these assets exceeds $350 million.
To determine whether these stocks can sustain their dividend increases, two key indicators should be evaluated. The payout ratio illustrates what fraction of a company’s net income is dedicated to dividends. Additionally, earnings growth plays a vital role.
A high payout ratio may hinder continued dividend increases, while a lower ratio suggests potential for expansion. Coca-Cola’s payout ratio stands at 77%, which is considered high.
Its earnings growth decreased in the last quarter, indicating that dividend increases may be limited in the short term. Conversely, American Express exhibited a 38% growth in earnings last quarter.
With a low payout ratio of 19%, the company appears well-positioned for several years of substantial dividend growth. Buffett’s investment principle of selecting firms with strong and growing dividends has proven effective for long-term success. This “secret ingredient” has contributed to Berkshire Hathaway’s remarkable achievements.
Although Coca-Cola and American Express have displayed impressive dividend growth in the past, their future prospects demand careful consideration of payout ratios and earnings growth.
