Warren Buffett is one of the world’s richest people. He is also one of the worlds most successful investors. He is one of the few individuals who have managed to compound money at high rates of return for close to 70 years.
He’s not only a great investor, but also a great communicator and educator. Buffett has managed to educate investors through his partnership letters, letters to Berkshire shareholders and tons of interviews and articles over the decades. His investments have been studied in detail, including by yours truly.
Some of his most prominent investments have included Coca-Cola (KO), Burlington Northern Santa Fe (BNSF) and See’s Candies.
In general, the long-term investments that he does tend to be in quality companies with favorable economics within his circle of competence, that are operated by able and trustworthy managers and are available at a good valuation. A lot of these companies tend to generate more cashflow from operations than they need to stay competitive and grow the business over time. As a result, these companies end up distributing those excess profits to Berkshire Hathaway coffers in Omaha, Nebraska. These dividends are then used by Buffett to be allocated wisely into other income producing assets.
The most fascinating aspect is that a lot of these companies end up sending a higher amount of cash back each year, while also growing their business.
This is where I wanted to share the concept of dividend payback. Dividend payback refers to the amount of dividends received from an investment, which exceeds the amount of capital paid for it.
In Buffett’s case, he has received more in cash dividends from Coca-Cola, BNSF and See’s Candies than what he invested in those businesses in the first place. These investments have more than paid for themselves. On the bright side, he also has a claim on their future earnings and dividends. In addition to that, these are all worth substantially more than what he paid for them.
The concept of dividend payback illustrates the importance of long-term investment in quality companies at attractive valuations, which are then able to grow the business and shower their shareholders with rising cash distributions for decades.
Coca-Cola Company
For example, Buffett invested $1.299 billion between 1988 – 1994 to acquire what is now 400 million shares of Coca-Cola (KO).
His cost basis is $3.25/share, and he earns $1.68/share in annual dividends. Buffett’s yield on cost on Coca-Cola is 51.73%! This means that every two years, he receives his original cost back. Yet, he still owns shares worth over $20 billion, and the right to any future dividends and capital appreciation.
Dividend Growth Investing truly is the gift that keeps on giving.
Since 1994, Berkshire Hathaway has received $8.484 billion in dividends. This is 6.53 times the original cost of $1.299 Billion. The stock paid $21.21/share in total dividends 1995 – 2020. This cash has been invested for the benefit of Berkshire shareholders into other great investments.
Burlington Northern Santa Fe
The second business I will discuss is Berkshire’s investment in Burlington Northern Santa Fe (BNSF)
Burlington Northern has distributed $41.28 billion in dividends to Berkshire Hathaway between 2010 and 2020.
For reference, Berkshire paid $32.50 billion between 2007 and 2010 to acquire Burlington Norther Santa Fe. The railroad has more than paid for itself in a decade, yet he still owns this prized asset, which would very likely continue spinning off dividends for decades to come.
This is the breakdown by year:
|
Year |
2010 |
2011 |
2012 |
2013 |
2014 |
2015 |
2016 |
2017 |
2018 |
2019 |
2020 |
|
Distributions to Berkshire in Billions |
1.24 |
3.50 |
3.75 |
4.00 |
3.50 |
4.00 |
2.00 |
4.58 |
5.45 |
4.43 |
4.83 |
Berkshire's acquisition of Burlington Northern Santa Fe is an example of having your cake and eating it too.
The stock has paid for itself after a decade. But Berkshire still owns the asset that would generate billions in distributions for decades.
For example, close competitor Union Pacific $UNP sells for 32 times its 2020 earnings. Burlington Northern earned $5.161 billion in 2020. Applying that same multiple means that BNSF is worth $165 billion, or about five times its valuation in 2010.
See's Candies
Last but not least is Buffett’s investment in See’s Candies. He purchased the chocolate maker in 1972 for $25 million, when sales were $30 million and pre-tax earnings were $5 million. The capital needed to run the business was $8 million, and had increased to $40 million by 2007. In other words, the company needed to reinvest only $32 million in the business between 1972 and 2007.
Yet, sales grew to $383 million and pre-tax profits grew to $82 million
For the 1972 – 2007 period, pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire.
In other words, each year Berkshire Hathaway receives more than it paid for See’s Candies.
That’s fascinating. This investment has paid for itself many times over.
Conclusion
Today, I discussed the concept of dividend payback, which is when an investment distributes more in dividends to its shareholders than what they originally paid for. I used three investments that Warren Buffett’s Berkshire Hathaway had made, in order to illustrate this concept.
The concept of dividend payback illustrates the importance of long-term investment in quality companies at attractive valuations, which are then able to grow the business and shower their shareholders with rising cash distributions for decades.
All of these three examples illustrate the idea that Warren Buffett likes receiving dividends, but doesn’t really like paying them. He is the best investor in the world, who is able to deploy those dividends into more income generating assets such as stocks or private businesses. Most management teams in Corporate America, including many of the Berkshire Hathaway investments and subsidiaries are better off sending out excess cash to shareholders in the form of dividends. As Berkshire Hathaway has gotten too large to find meaningful acquisitions, perhaps the time for a regular dividend is long overdue.
I apply the lessons from these examples in my own investing as well. I generally look for businesses that grow earnings and dividends, and are available for a good price today. I do expect that a good chunk of the companies that I end up holding for the next 20 – 30 years would most definitely pay for themselves in dividends alone. My expectation is that these companies would be providing me with rising dividend income along the way, that beats inflation. This is the appeal of dividend growth investing for me – generating passive dividend income that grows above the rate of inflation, in order to pay for expenses in retirement. In the accumulation phase, I can allocate those dividends to buy more income producing assets and diversify my portfolio. In the retirement phase, I use those dividends to pay for expenses. In the long run, most investments would pay for themselves, while also appreciating in value. That’s having your cake and eating it too.
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