This Buffett Technique Will Increase Your Dividends

Published in Investing on 8 June 2012

This is how one Fool is planning to beat annuity rates when he retires.

Billionaire investor Warren Buffett is well known for his focus on companies with strong earnings that pay good dividends. At the same time, he doesn't care much about share prices -- except when he's buying.

Buffett's investment style is as far as away as you can get from the aggressive, heavy trading approach pioneered by hedge funds -- but his returns are far more consistent and much easier for investors like you and I to replicate.

Here's the secret.

Buffet's 50% yield

One of Buffett's most famous long-term holdings is his 8.9% stake in The Coca-Cola Company (NYSE: KO). The $15bn shareholding is Buffett's company Berkshire Hathaway's largest holding and most of it dates back to 1988, when Berkshire spent $1bn to acquire a 6.2% stake at an approximate cost, adjusted for splits and dividends, of $3.75 per share.

Back in 1988, Coke shares offered a yield of 4% -- decent, but not amazing. Since then, the company has maintained its 50-year unbroken record of annual dividend increases. The result is that in 2011, the dividend payout was $1.88, providing Buffett with a massive 50% yield on his original investment.

Yield on cost

Despite its golden record of annual dividend increases, Coca-Cola is not necessarily thought of as a high-yielding stock: at current prices, it only yields around 3.1%.

This 50% is Buffett's 'yield on cost' -- the dividend yield on the price he originally paid. This is one the key benefits of holding shares in big companies over long periods, as I'll demonstrate below.

By simply maintaining his holding in a good quality company, Buffett has seen the yield on his shares rise continuously to provide an amazing 50% annual return on his original investment.

A British Coca-Cola?

Over the last 6 years, Buffett has spent more than £1bn building up a 5.1% stake in one of Britain's best-known brands -- a company with a 28-year unbroken record of dividend increases.

I'm pretty sure he likes this company for just the same reasons he liked Coca-Cola all those years ago -- and you can find out the name of the company and the price he paid in this free report.

You can do it too

The good news is that you don't have to wait 24 years to see big yield on cost increases in your portfolio.

In the table below, I've taken a look at nine popular FTSE 100 shares to see what their yield on cost would be today if you'd bought them just ten years ago, in May 2002. I think that the results speak for themselves:

CompanyMay 2002
share price
2002 yield
on cost
2011 yield
on cost
British American Tobacco (LSE: BATS)793p1.4%15%
SSE (LSE: SSE)679p4.8%11%
Vodafone (LSE: VOD)118p1.3%7.5%
Tesco (LSE: TSCO)246p2.5%6.0%
Unilever (LSE: ULVR)1,396p1.5%5.6%
BAE Systems (LSE: BAE)* 371p2.5%5.1%
Diageo (LSE: DGE)856p2.8%4.7%
GlaxoSmithKline (LSE: GSK)* 1,477p2.7%4.7%
HSBC (LSE: HSBA)* 830p4.0%3.1%
Average yield:-2.61%6.97%

Source: Morningstar, company websites

* These share prices are currently lower than they were in 2002. Despite this, in 2/3 cases they still offer a yield on cost that is better than it was ten years ago. What's more, a Foolish investor would have used the falling share price as an opportunity to buy more and average down, thus improving their yield on cost still further.

Standout performer British American Tobacco has become a truly outstanding income share, thanks to a combination of share price growth and dividend increases. In second place is one of the most popular utilities with private investors, SSE, which also has an impressive record on the dividend front.

Annuity crunching

According to the Annuity Best Buy Table in today's Financial Times, a male aged 65 with a £100,000 lump sum can get a level annuity income (i.e. not inflation-linked) of £5,971 -- effectively a 5.9% yield on your capital sum.

Throw in a 3% annual rise to protect you from inflation, and that drops to £4,131 -- or 4.1%. Remember, this is for an annuity, so you lose your lump sum in return for your annual income.

Compared to this, I reckon our high yield on cost dividend portfolio is far superior:

  • 6.97% yield
  • You keep your capital
  • If your shares are in an ISA, you won't pay income tax on the dividends
  • Over time, your dividends will tend to stay ahead of inflation

Of course, a portfolio like this is riskier than an annuity, as some of the companies in it could go through troubled times -- think about Lloyds Banking Group (LSE: LLOY) and Royal Bank of Scotland (LSE: RBS), for example.

However, the longer you hold your shares, the more your yield on cost will improve, reducing the impact if one company goes pear-shaped.

Keep it simple

The best part of this approach is that assembling a high-yielding portfolio that will show yield on cost improvements over the next couple of decades is really simple.

All you need to do is choose a diversified mixture of big cap shares from different sectors (I'd stick to the FTSE 100), stick them in an ISA or SIPP and wait. Many FTSE 100 companies look excellent value at the moment and there really is no time like the present.

Finally, don't forget to check out that free report I mentioned about Warren Buffett's favourite UK share. I found it really useful and I think you might still be able to get it at the same price he paid, so it's definitely worth a look.

Searching for dependable FTSE dividend shares? This free Motley Fool report -- "8 Shares Held By Britain's Super Investor" -- reveals the major companies favoured by high-yield legend Neil Woodford.

Further investment opportunities:

Roland owns shares in Vodafone, Tesco, Unilever, BAE Systems, GlaxoSmithKline and HSBC. He does not own any of the other shares mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

AleisterCrowley 08 Jun 2012 , 4:26pm

Is yield on cost actually useful?
OK it's a nice way to 'keep score', but surely you need to look at the current yield.
If I'd got CocaCola with YoC 50%, current yield 3.1% I'd be inclined to cash in the gains and move the capital to another share paying 5%+

blackwhite 08 Jun 2012 , 4:41pm

Another column with today's yield would be good to compare, for example isn't Vod about the same, keeping pace?

Claphamchap 08 Jun 2012 , 4:50pm

Does anyone know the ftse 100 2002 and 2012 yield on cost for the same dates so that we can compare to a tracker investment?

duffmanchon 08 Jun 2012 , 5:45pm

"If I'd got CocaCola with YoC 50%, current yield 3.1% I'd be inclined to cash in the gains and move the capital to another share paying 5%+"
That is the difference between most investors and Buffett, patience.

ANuvver 08 Jun 2012 , 6:14pm

"If your shares are in an ISA you won't pay income tax on dividends"
Well, you can see where I'm going here. Subs!

With this kind of strategy, tax planning is very important.

In contrast to purchasing an annuity, capital value on a purely income pf suddenly becomes rather unimportant, particularly if it's anchored on a spread of big blues. The ideal would be an income pf that beats inflation and generates at least a modest surplus above your projected income needs so you can compound a little back into the mix here and there.

Avalaugh 08 Jun 2012 , 10:42pm

If I'd got CocaCola with YoC 50%, current yield 3.1% I'd be inclined to cash in the gains and move the capital to another share paying 5%+

It's not about yield its about dividend growth, use this calc to see its effect:
http://buyupside.com/calculators/dividendreinvestmentdec07.htm

We need more articles on divi growth!

Hannibalis 09 Jun 2012 , 10:40am

The article makes some good points but I did some sums of my own a while ago

http://www.the-diy-income-investor.com/2011/07/high-yield-or-dividend-growth.html

Dividends, as the article points out, are not always for ever - companies have the freedom to cut them or cancel them completely. By focusing on those that have survived unscathed, there is a fair bit of survivorship bias at work.

http://www.the-diy-income-investor.com/2012/04/how-reliable-are-dividends-uk.html

By contract, fixed-income securities can often provide much higher yields on cost and a much less likely to fail. My preference now is a combination of the two - 50/50 to keep it simple.

gimpex 10 Jun 2012 , 5:50am

A related question if you dont mind :
I am sitting with approx 7000 SBRY shares , currently in the red. Should I a) top up with more SBRY or b) "diversify" into TESCO ? Why?

For the sake of this discussion , I would like to stick to above , and not discuss what else I could do with the money. I have other holdings in approx same value each - all solid companies frequently discussed here (including some on the list above).

Thank you

ANuvver 10 Jun 2012 , 12:53pm

gimpex:

What was your investment case for accumulating SBRY? If you were coming to them cold right now, would you still feel the same way? It's very difficult to answer that objectively, since you have to try to disregard your disappointment in your existing stake. FWIW, topping up on winners is even harder.

I think, as far as humanly possible, you need to regard each new investment you make as a standalone entity. "Averaging down" can make a spreadsheet look prettier and you do need to be on top of the concept for tax purposes, but it shouldn't be a main consideration.

As for diversifying, well the same logic applies. Holding a brace of competitors is a reasonable sectoral hedge - the classic in pharma is AZN/GSK - but it shouldn't be your primary concern. The point is, and given that you like the sector, right now, which of SBRY or TSCO looks the better prospect to you?

Wishy-washy response, I'm afraid.

BFTB 11 Jun 2012 , 1:05pm

The striking point to me in the table provided is 3 of the 10 shares shown are below their 2002 price. And, with the possible exception of BAT and SSE none are really providing a great yield on their cost 10 years ago. I guess the table doesn't include returns of capital - VOD returned about 10% in 2004 if I remember rightly - but it still makes for pretty depressing reading overall.

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