UPDATE: The charts in this story have been updated to reflect today's market prices.
Warren Buffett has 19 dividend stocks with a 2.0% or better yield in his portfolio, but which are the best? I've used a systematic approach to find the seven best -- and rank them, from "worst" (honestly, they're all great) to best.
Warren Buffett's investment style is a culmination of value, growth, and quality.
He looks for:
Great business (quality)
Trading at fair or better prices (value)
That will compound his money far into the future (growth)
This approach leads Buffet to invest primarily in dividend stocks. Dividend stocks make up around 92% of Buffett's portfolio. His top four holdings have an average position weighted dividend yield of 3.2% and make up 63% of his portfolio. High quality dividend growth stocks are the cornerstone of Buffett's portfolio.
What makes money for Buffett can make money for you. Here's a systematic approach to finding which of Buffett's dividend stocks are the best.
The first criteria: A dividend yield of 2.0% or more. Dividend investors need a reasonable starting yield for future dividend growth to be worthwhile. A stock that grows its dividend payments by 1,000% is great. If the starting yield was just 0.1% the company would have a 1.0% yield after its growth. That's not the type of investment we are looking for. Buffett's portfolio currently has 19 stocks with yields of 2.0% or higher. You can see all of Buffett's highest yielding stocks here.
From there, we systematically rank the stocks in Buffett's portfolio based on three metrics:
- Dividend yield (the higher the better)
- Payout ratio (the lower the better)
- 10 year growth (the higher the better)
Higher dividend yields mean more income. All other things being equal, the higher the dividend yield, the better.
Lower payout ratios give management room to grow dividends faster than the business grows. Low payout ratios also make it less likely a business will have to cut its dividend if earnings were to fall.
10 year growth shows how fast a company has grown over the last decade. A 10 year time frame captures a full economic cycle. Five year growth is too short. It would only capture a bullish period.
The 10 year growth number is the lower of earnings-per-share and dividend growth. Businesses can increase their payout ratios and show unsustainable dividend growth. A company's management may also choose to grow dividends slower than earnings-per-share. The lower number between dividend and earnings-per-share growth is a more accurate estimate of future dividend growth in both cases.
Of Buffett's 19 stocks with 2.0%-plus dividend yields 13 have 10 year earnings-per-share and dividend per share histories, and positive earnings in their last fiscal year. Ranking by yield, growth, and payout ratio are some of the metrics that matter used in The 8 Rules of Dividend Investing.
This article analyzes the top half (top 7) of Buffett's stocks based on the dividend growth metrics discussed previously.
Keep reading this article to see Buffett's 7 best stocks for dividend growth analyzed in detail.
- Yield rank: 9th out of 13
- Payout ratio rank: 7th out of 13
- Growth rank: 5th out of 13
Note: The lower the rank the better (1 is best). Rank is based out of the 13 Buffett stocks that qualified for analysis. All metrics are weighted evenly.
UPS is the world's largest delivery company. The company was founded in 1907. Today, UPS operates in virtually every country and territory in the world. It has a market cap of $94.02 billion.
UPS has grown its dividends at 8.3% a year over the last decade. Earnings-per-share have grown at 4.6% over the same time period. Using the lower of dividends and earnings-per-share growth, UPS's growth rate is 4.6%.
The company currently offers investors a dividend yield of 2.9%. UPS's dividend yield plus its expected growth rate gives shareholders expected total returns of 7.5% a year going forward -- if the company continues growing at around the same rate it has over the last decade.
A 7.5% expected total return may not be the most eye-catching in the world, but safety matters. And UPS's dividend is very safe. The company has a reasonable payout ratio of 54%. The company has also increased its dividend payments every single year since 2001 -- including through the Great Recession.
There's no question UPS has a strong and durable competitive advantage. As a delivery company grows, the value it can provide customers increases. Need to ship a package to Tunisia? UPS has you covered. Smaller businesses cannot compete. Additionally, the larger the company gets the more efficient its routes become. These beneficial economies of scale make it very likely UPS will continue to grow long into the future.
The company is currently trading for a price-to-earnings ratio of 19.2, which is well below the S&P 500's current price-to-earnings multiple of 24.8.
- Yield rank: 5th out of 13
- Payout ratio rank: 12th out of 13
- Growth rank: 3rd out of 13
Buffett has had a long love affair with Coca-Cola. He first began purchasing the stock in 1987. 29 years later, and Coca-Cola is still one of Buffett's largest holdings.
It's easy to see why Buffett loves this branded drink manufacturer: The company is one of the most durable, predictable businesses around.
Coca-Cola was founded in 1892. The company has paid increasing dividends for 54 consecutive years. This makes Coca-Cola one of just 18 Dividend Kings; stocks with 50 or more years of consecutive dividend increases.
Coca-Cola is more than just its namesake brand. The company has a total of 20 brands that generate more than $1 billion a year in sales. While the company is known for its soda brands, 14 of its 20 billion dollar brands are non-carbonated. This includes brands like Simply juices, Gold Peak tea, and Vitamin Water.
The company's stock currently offers investors a dividend yield of 3.3%, well above the S&P 500's dividend yield of 2.1%. Coca-Cola pays out the bulk of its earnings as dividends. The company currently has a 77% payout ratio. Coca-Cola can sustain a high payout ratio because its operations are so stable.
When a business pays out the bulk of its earnings as dividends, there isn't much left over to reinvest in growth. Because of this, high payout ratio stocks tend to be slower growers, but that isn't the case with Coca-Cola.
The company has compounded earnings-per-share at 6.3% a year over the last decade. Dividends have grown faster -- at 9.0% a year over the same time period. The company's dividend yield combined with its historical earnings-per-share growth rate gives investors expected total returns of 9.6% a year going forward.
- Yield rank: 1st out of 13
- Payout ratio rank: 9th out of 13
- Growth rank: 9th out of 13
Verizon's dividend yield of 4.5% immediately stands out. It is the highest of the 13 dividend growth stocks in Buffett's portfolio. Verizon's dividend yield is more than double that of the S&P 500. It is a rarity to find quality businesses with high yields in today's low interest rate environment. But Verizon is just that.
Verizon and AT&T(T) - Get Report are by far the two largest wireless providers in the United States. Both have around a 35% market share. Verizon's large market share in a utility-like industry gives it earnings stability. The company has a fairly high payout ratio of 63.8%, but its stable earnings make this a reasonable payout ratio.
Growth has not been rapid for Verizon over the last decade. The company saw earnings-per-share grow 4.5% over the last 10 years. Dividends have grown slower, at 3.2% a year.
Verizon's management hopes to spur growth with a slew of recent acquisitions -- and they have spared no expense. The company has made the following mutli-billion dollar acquisitions in its recent history:
These large acquisitions position Verizon for the future. The company is looking to accelerate growth through bolstering its media and advertising capabilities with AOL and Yahoo!. Verizon is expanding its focus from being a wireless provider to being a wireless and content provider. The Fleetmatics acquisition is a move to strengthen Verizon's in-car and 'internet of things' business. With potentially billions of devices that could be connected to the internet, Verizon stands to be a major player in this rapidly growing industry.
While Verizon's future growth may well be better than growth over the last decade, that is far from guaranteed. Using historical growth as a gauge of future growth tends to be a better guide than guessing at unpredictable future technology growth.
Verizon shareholders should expect total returns of around 7.7% a year (conservatively) based on the company's 3.2% historical growth rate and current 4.5% dividend yield.
- Yield rank: 10th out of 13
- Payout ratio rank: 4th out of 13
- Growth rank: 4th out of 13
The scale of Walmart's business is hard to fathom. The company has generated $483 billion in sales over the last year. That's more than Amazon(AMZN) - Get Report , Costco(COST) - Get Report , and Target(TGT) - Get Report combined. Walmart is still the undisputed king of discount retail -- despite the buzz around Amazon (and to a much lesser extent, Costco).
Success is nothing new for Walmart. The company is a member of the exclusive Dividend Aristocrats list. The Dividend Aristocrats Index has outperformed the market by an average of 3.2 percentage points a year over the last decade. To be a Dividend Aristocrat, a company must have 25 or more years of consecutive dividend increases, and be a member of the S&P 500. Walmart easily qualifies, having paid increasing dividends for 43 consecutive years.
Walmart has grown earnings-per-share at 5.7% a year over the last decade. Dividends have grown much faster -- at 12.6% a year. The company's dividends have grown quicker as Walmart increasingly saturates viable markets with its stores. The Walmart of today simply does not have as much room to expand as the Walmart of a decade ago.
Walmart's growth has stagnated in recent years as the company shifts strategy. Walmart's management has made a firm commitment to compete in online sales and boost lagging comparable store sales. To this end, the company has invested heavily in its employees; increasing pay and training. The raises appear to be working; Walmart has seen comparable store sales grow in the United States for seven consecutive quarters.
The company's online investments have spurred online growth for the company -- but Walmart must do better in the category. The company recently announced it will acquireJet.com for $3.3 billion in a move to further upgrade its e-commerce capabilities.
Over the next year or two, Walmart's growth will likely be stagnant as it continues to invest heavily. From then on, I expect the company to return to its historical growth rate of around 5.7% a year. This growth combined with the company's current 2.7% dividend yield gives investors expected total returns of 9.4% a year.
- Yield rank: 8th out of 13
- Payout ratio rank: 6th out of 13
- Growth rank: 2nd out of 13
Deere & Company is the global leader in agricultural equipment manufacturing. The company has a very long corporate history; it was founded in 1837. Today, Deere & Company has a market cap of $25.76 billion.
Deere & Company operates in a cyclical industry. When agricultural prices fall, farmers tend to hold off on buying new equipment. This makes Deere & Company's earnings less stable than many of the other high quality dividend growth stocks on this list. For example, earnings-per-share declined from $9.08 in 2013 down to $5.76 in 2015.
Because of Deere & Company's more volatile earnings, the company cannot maintain as a high of a payout ratio (at least not safely) as the Verizon's and Coca-Cola's of the world. When business is booming, the company's payout ratio is usually under 30%. During market troughs, the company's payout ratio can hit the low 60% range. Even during low earning periods, the company's dividend is safe thanks to its low average payout ratio. Deere & Company currently has a payout ratio of 47.8%.
Don't be fooled by the company's recent earnings-per-share decline over the last few years; Deere & Company is a dividend growth stock. Over the last decade, the company has compounded its earnings-per-share at 7.0% a year. Dividends have grown much faster -- at 14.7% a year. The company's historical growth rate of 7.0% is likely understated because earnings are currently depressed. Deere & Company has historically sustained a double-digit growth rate measuring from peak-to-peak earnings or trough-to-trough earnings.
Even using the likely too-low growth rate of 7.0% a year, Deere & Company investors can expect total returns of 9.9% a year from the company's expected growth and 2.9% dividend yield. The company makes a compelling portfolio addition for investors looking for exposure to the agricultural industry.
- Yield rank: 4th out of 13
- Payout ratio rank: 2nd out of 13
- Growth rank: 7th out of 13
The idea of long-term investing comes up repeatedly when you analyze Buffett's investing patterns.
"When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever."
- Warren Buffett
Buffett is a long-term holder of Wells Fargo stock (just like he is with Coca-Cola). He first bought into the company in 1989. It is still one of the most important parts of his portfolio 26 years later. Wells Fargo is Warren Buffett's 2nd largest stock holding (behind only Kraft-Heinz).
Wells Fargo has been scrutinized by the financial press recently (and rightly so). Wells Fargo employees opened up 2 million unauthorized employee accounts in order to meet sales goals. Obviously, this is unethical behavior. The company was fined $185 million and is under investigation by the House Financial Services Committee.
Wells Fargo avoided much of the risky lending practices that hurt much of the financial sector during the Great Recession. The company has (or at least, recently had) a reputation of prudent risk management and ethical behavior.
The recent scrutiny has caused Wells Fargo stock to decline 6.5% over the last month. When share prices fall, opportunistic investors can buy into great businesses at a discount.
And make no mistake, Wells Fargo is still a great business. The company currently has a 3.4% dividend yield and a payout ratio of just 36.7%. Wells Fargo appears undervalued at this time based on its price-to-earnings ratio of just 11.2.
The company managed to grow earnings-per-share at 6.4% a year and dividends at 4.0% a year over the last decade. The last decade has been difficult for banks due to low interest rates and the Great Recession. Still, Wells Fargo has compounded investor wealth at rates well above inflation over this time.
Using the company's 4.0% historical growth rate and adding its current dividend yield of 3.4% gives investors total expected returns of 7.4% a year before valuation multiple gains. Valuation multiple gains are likely given the depressed share price and low price-to-earnings ratio of Wells Fargo. The company makes a compelling purchase at current prices for investors looking for exposure to the banking industry.
- Yield rank: 3rd out of 13
- Payout ratio rank: 5th out of 13
- Growth rank: 1st out of 13
Warren Buffett's highest ranked dividend growth stock is IBM. IBM is one of Buffett's largest holdings. The stock currently makes up 9.5% of Buffett's portfolio.
Buffett shocked the investing world when he began purchasing IBM stock in 2011. He had (up to that point) historically avoided technology stocks, saying he "didn't understand them." It is difficult to imagine someone as intelligent as Buffett not being able to grasp the business models of any technology stocks.
More likely, the Oracle of Omaha avoided technology stocks because of how quickly the industry changes. Slow changing industries (banking, consumer goods, etc.) are less prone to rapid change. Coca-Cola isn't going to go the way of Kodak because of some wild technology change, for example.
The reality is IBM is different than most technology companies. IBM is a high quality blue chip stock. It has a high 3.6% dividend yield and has been in operation over 100 years; IBM was founded in 1911. There are very few technology companies that have proven their brand helps insulate them from the quickly changing trends in the technology industry.
The technology industry (and IBM) have changed tremendously over the last decade. In that time period, IBM has managed to compound earnings-per-share at 10.0% a year and dividends at a break-neck 20.4% a year pace.
The company has a fairly low payout ratio of 43.0%. It uses retained earnings to buy back shares, which increases investor value on a per share basis. IBM continues to transition to better growth opportunities. If the company can maintain its historical 10.0% a year earnings-per-share growth rate, investors can expect total returns of 13.6% a year from dividends and growth.
IBM stock is cheap at current prices. The company is trading for a price-to-earnings ratio of just 12.5. IBM's prominent position in Buffett's portfolio, its high historical growth rate, low price-to-earnings ratio, and high dividend yield make it a compelling purchase for dividend growth investors looking for exposure to the technology sector.
This article is commentary by an independent contributor. At the time of publication, the author held positions in TGT and WMT.