Finding dividends that keep on giving.
In investing parlance, "multi-bagger" is a term used to describe stocks that have multiplied in value -- a share that's trebled, for example, is a "three-bagger" and so on.
Multi-baggers tend to be really exciting events, tend to garner media attention, and can happen in a relatively short period of time. In fact, as of 7 March, twenty FTSE All-Share constituents, including ARM Holdings (LSE: ARM) and Hochschild Mining (LSE: HOC), have more than doubled over the past year and reached multi-bagger status.
It works for dividends, too
As the lead advisor at Dividend Edge, I'd also like to take a moment to recognise the more infrequent and unheralded, yet incredibly impressive, occasion of what I call an "Income Amplifier" -- an investment whose annual dividend payments have doubled at least once over. For example, an investment that paid £40 in dividends in year one would reach income amplifier status when the annual dividends received exceed £80.
Here are five UK companies that have achieved income amplifier-status for those investors who've bought and held the shares for at least five years:
| Company | Dividend
per share
2005 | Dividend
per share
last 12 mths |
|---|
| British American Tobacco (LSE: BATS) | 47p | 114.2p |
| Reckitt Benckiser (LSE: RB) | 39p | 115p |
| Capita (LSE: CPI) | 7p | 20p |
| Sage Group (LSE: SGE) | 3.6p | 7.8p |
| Wm. Morrison (LSE: MRW) | 3.7p | 8.2p |
* Data provided by CapitalIQ and company filings
Warren Buffett also described such an income amplifier situation in his most recent shareholder letter:
"Coca-Cola paid us $88 million [in dividends] 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. "
Between 1995 and 2010, Coca-Cola's dividend payments to Buffett's Berkshire Hathaway quadrupled -- an income amplifier four times over.
And if his expectations are correct, by 2021, it will be an amplifier nearly nine times over, yielding nearly 60% per year on his originally invested capital.
Yes, this is the Oracle of Omaha we're talking about here, but income amplifiers aren't out of reach for the individual investor.
Let's take a closer look at how Buffett turned Coca-Cola into a multi-income amplifier and glean some lessons. I realise most of the figures are in US dollars, but the lessons remain the same for UK investors.
Coke and a smile
In 1988, Berkshire Hathaway began accumulating shares of Coca-Cola, just a few months after the stock market crash in October 1987.
Over the course of the year, he purchased $592 million (today, £364 million) worth of Coca-Cola shares at an average split-adjusted price of $5.23 -- some 20% below Coca-Cola's pre-crash levels. These shares posted an average dividend yield of 2.9%, which was below the S&P 500 market average of 3.7% at that time.
In subsequent years, Buffett made two additional investments in Coca-Cola:
| Year | Amount
invested | Average
share price
purchased | Average
yield | S&P
average
yield |
|---|
| 1989 | $431m | $5.87 | 2.9% | 3.3% |
| 1994 | $274m | $20.83 | 1.9% | 2.9% |
*Derived from Berkshire shareholder letters, Coca-Cola dividend history, and Bloomberg.
All figures are split-adjusted
Having made a nearly $1.3 billion investment in Coca-Cola over the course of six years, Buffett did perhaps the most remarkable thing of all -- nothing. In fact, he simply did what he said what he would do in his 1988 shareholder letter:
"When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever."
Lessons learned
Here are some takeaways from Buffett's Coca-Cola success:
1. Great dividend track record
By the time Buffett made his first purchase of Coca-Cola in 1988, the company had been paying dividends since 1893 and had raised its payout each year since 1962. Though Buffett may not have purchased Coca-Cola for the dividend alone, it was clear by 1988 that the company had the financial strength and confidence in its prospects to pay increasing dividends. Before recommending a dividend-paying share at Dividend Edge, we always look for a good track record of payouts that go back at least ten years.
2. Determine competitive advantages
Buffett recently said that "The single most important decision in evaluating a business is pricing power." Coca-Cola, for example, is able to pass on rising costs to consumers because of its globally-recognized brand name. Over the years, this advantage helped the company maintain margins and expand into new markets. Be wary of buying shares in businesses that have few competitive advantages or pricing power.
3. Wait for your opportunities
A good business is not always a good investment. Certainly Buffett could have purchased Coca-Cola in 1987 when it was trading around $6.50 a share and still achieved strong results in the long-term, but his returns -- both in dividend and capital gains terms -- are much better because he waited for a better price. At Dividend Edge, we aim to close at least 75% of our trades for a profit, so buying shares at a good price matters quite a bit to us.
4. Yield isn't everything
Each time Buffett purchased shares, Coca-Cola's yield was below the market average, but that didn't stop it from being a very fine dividend-paying share. Adding a helping of dividend growth shares can help keep your portfolio's income returns ahead of inflation.
5. Be patient
This is probably the hardest thing to do, but as Buffett noted in his most recent shareholder letter, "Time is the friend of the wonderful business." Even if you find a good dividend-paying share, it takes approximately seven years for a dividend to double assuming a 10% annualised growth rate. Once you've invested in a good company at a good price, you need to give that business time to flourish if you expect to attain an income amplifier. At Dividend Edge, we aim to own our investments for at least five years, although that will not always turn out to be the case.
Even though Buffett's investments were in the millions, the amount of investment matters little -- an individual investor who invested a few thousand in Coca-Cola at the same prices as Buffett did would have had just as much success performance-wise and achieved income amplifier status many times over, just in much smaller nominal terms.
At Dividend Edge we're building a £20,000 real-money portfolio of dividend-paying shares using these very strategies. We started in November last year and we recently bought our sixth share.
If you'd like to learn more about the service, you can take a free 30-day trial. I look forward to seeing you!
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> Todd does not own shares of any company mentioned.
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Risk Warning
- The prices of all shares, and the income from them, can fall as well as rise.
- You run an extra risk of losing money when you buy shares in certain smaller companies including "penny shares".
- There is a big difference between the buying price and the selling price of these shares. If you have to sell them immediately, you may get back much less than you paid for them. The price may change quickly, it may go down as well as up and you may not get back the full amount invested. It may be difficult to sell or realise the investment.
- You should not speculate using money you cannot afford to lose, or rely on dividend income for non-discretionary living expenses.
- Some securities may be traded in currencies other than sterling, and may also pay dividends in other currencies. Changes in rates of exchange may have an adverse effect on the value of these investments in sterling terms. You should also consult your stockbroker about any additional dealing or administrative charges.
- We have taken all reasonable care to ensure that all statements of fact and opinion contained in this publication are fair and accurate in all material aspects.
- Investors should seek appropriate professional advice from their stockbroker or other adviser if any points are unclear.
- This newsletter gives general advice only, and the investments mentioned may not necessarily be suitable for any individual.
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