What’s in Warren Buffett’s “Secret Sauce?” In his latest shareholder letter, the Oracle of Omaha shares one of his key ingredients for success: dividend-paying stocks.
When equity markets are climbing, dividends often take a back seat to capital gains for investor focus. As we continue through a period of slower economic growth, and with interest rates rising from substantial lows, we shouldn’t underestimate the significance of dividends to portfolio growth.
Buffett’s investments are expected to generate a whopping $5.7 billion in cash this year, the majority from dividends.1 In his letter, he points to two successful dividend-paying investments and the contribution of both dividend growth and share price appreciation in growing portfolio values over time. He compares these to a high- quality bond, referring to it as a “flat-lined” investment that would retain, not grow, its value and pay an unchanged coupon rate from year to year.2 It’s good food for thought: dividends, alongside share price appreciation, can contribute to substantial growth over time. Consider an investment of $100,000 in the S&P/TSX Composite Index 30 years ago. It would yield $628,273 by investing in the index alone; yet, with reinvested dividends, the value would grow to $1,318,767.3 Buffett also credits a handful of solid investment choices and the magic of compounding over time.
Today, the S&P/TSX Composite Index has a dividend yield of around 3.12 percent, almost double that of the S&P 500 at 1.67 percent.4 Many quality Canadian companies pay dividends, some with yields between 4 and 6 percent. Consider that the equivalent pre-tax interest income would be around 5.2 to 7.8 percent for an average high-net-worth taxpayer.5 Indeed, dividends still lead the way in tax savings over interest, with eligible dividends from Canadian corporations taxed at a rate that is lower than interest income.
This is in addition to the prospect of future share price growth, as well as future increases in dividend payouts, as Buffett reminds us. Many companies that have historically paid dividends continue to pay dividends, and increase their dividends even through more challenging economic times — for example, the “Dividend Aristocrats,” a group of companies that have had 25 years of consecutive dividend increases in the U.S., and 5 years in Canada.
Dividends remain an excellent income source that can meaningfully contribute to portfolio growth over time. Don’t overlook the fact that they continue to work hard behind the scenes within a portfolio.
1. www.wsj.com/articles/warren-buffetts-secret-sauce-involves-one-of-investings-most- basic-strategies-f96c4894;
2. www.berkshirehathaway.com/letters/2022ltr.pdf; 3. S&P/TSX Composite and Total Return Indices, 01/29/93 to 1/31/23 (3,305.47 to 20,767.40; 6,124.83 to 80,772.20); 4. At 04/28/23. Of course, this is because of the significant portion of growth stocks that make up the S&P 500 that typically do not pay dividends; 5. Based on average marginal tax rates for $250,000 of income in 2023: 50.25% for ordinary income and 35.02% for eligible dividends, which are averages across provinces/territories.