There is no question that Warren Buffett is actually the best investor the world has ever known. He started out with only a few hundred dollars in the year 1956, yet he managed to transform that money into $20 million in 1969 when he liquidated Buffett Partnership Limited. By this point in time, his entire net worth was tied up in Berkshire Hathaway stock, which was a small textile mill that he transformed into a diversified business conglomerate.
After reading many SEC filings and checking out the letters to shareholders, we have noticed an interesting trend in Berkshire Hathaway’s long-term investments. It is most notable that Warren Buffett has focused his investing in companies that can grow their income without having to invest additional capital. This is very possible if the company you invest and has strong pricing power, because the consumers are currently addicted to the brand name product or the company possesses another strong type of competitive advantage. Purchasing See’s Candies in 1972 is an excellent example. Warren Buffett mentioned the following in his 2007 letter to his shareholders:
“We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million.
Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses.”
It is quite evident that Warren Buffett likes to invest in companies that need minimal capital, and they utilize their profits in order to purchase other businesses. This is very similar to what a typical dividend investor does – they accumulate distributions and then reinvest them in other high quality long-term opportunities.
In reality, the See’s Candies investment in 1972 is producing incredible yields on cost at this time. The same holds true for American Express, Coca-Cola and the Washington Post, which have all resulted in double and sometimes triple digit yields on cost.
During the year 1973, Warren Buffett opened a position in the Washington Post in the amount of $10,628 million. The effective cost basis of those shares are $6.15 per share. Since they are currently at an annual dividend of $9.80 per share, Berkshire Hathaway enjoys a 159% yield on cost.
Between the years 1991 and 1994, Warren Buffett picked up over 151,670, 700 million shares of the company American Express for a total cost of $1.287 billion. This amount, when translated, is $7.96 per share. When he initially invested in the company, it was by purchasing preferred shares which he could convert into ordinary shares at a fixed price, plus additions to his holdings. With the current annual dividend of $.80 per share, his yield on cost is over 10%.
Between the years 1988 and 1994, Berkshire Hathaway picked up over 400 million split-adjusted shares of Coca-Cola four $1.30 billion. The average cost per share of this purchase is in the neighborhood of approximately $3.25 per share.
If you base this on an annual dividend of $1.02 per share, Berkshire Hathaway has a stunning yield on cost of 31.40% per year. This simply means that by accumulating the dividends for over three years, Berkshire Hathaway is capable of accumulating its entire investment and fully recovering the total amount. But the beauty is they still retain the ownership of their Coca-Cola shares, and can gather future dividend distributions. This is what Warren Buffett said in his 2010 letter to shareholders:
“Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn’t be surprised to see our share of Coke’s annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business.”
As Berkshire Hathaway group bigger and had to allocate their billions of dollars on a monthly basis, it’s unfortunate that Warren Buffett had to focus mostly on large-cap elephant sized acquisitions. A prime example is the 2010 acquisition made by Berkshire Hathaway when purchasing Burlington Northern Santa Fe railroad.
It’s interesting to note that the majority of the businesses purchase by Warren Buffett, such as FlightSafety International, Geico, and Wesco Financial also achieved either dividend champions or dividend achiever status. He likes to purchase wide moat companies of quality that are growing in earnings, that they large and rising dividends.
These dividend payments are often reinvested into other businesses, which expand Berkshire Hathaway’s cash flow availability to dramatically reinvest. This is a very good strategy, and it’s one used by many dividend growth investors to this very day.