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Analyzing Warren Buffett’s 2 Newest Dividend Buys

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Analyzing Warren Buffett‘s 2 Newest Dividend Buys by Ben Reynold,

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Warren Buffett is one of the greatest investors of all time.  He has grown Berkshire Hathaway (BRK.A) (BRK.B) to a market cap of over $360 billion.

Every 3 months, Berkshire Hathaway is required to release its stock holdings in something called a ‘13F’ filing.

The company released its newest 13F filing in mid-August.  Buffett’s Berkshire Hathaway purchased more of 2 well-known dividend stocks…

But first, it’s important to understand the degree to which Buffett is a dividend investor.

  • 92% of Berkshire’s stock portfolio is invested in dividend stocks
  • Berkshire’s top 4 holdings have an average dividend yield of 3.1%
  • Berkshire’s top 4 holdings make up 63% of its total stock portfolio

The facts are clear; Berkshire’s portfolio is invested predominantly in above-market yielding dividend stocks.  You can see Berkshire’s 20 highest yielding dividend stocks here.

The 2 dividend stocks Buffett and his investment team decided to purchase more of are Apple (AAPL) and Phillips 66 (PSX).  Both are analyzed in detail in this article.

Berkshire Dividend Buy #1:  Phillips 66

Berkshire Hathaway purchased 3.2 million new shares of Phillips 66 in the company’s most recent quarter.  Berkshire now owns 15% of Phillips 66.

Berkshire has bet big on this United States based oil refiner.  It currently makes up 4.8% of Berkshire’s portfolio.

Phillips 66 is the largest refiner in the United States based on its $40.7 billion market cap.  The company operates in 4 distinct segments.  Each segment is shown in the image below:

Source:  Source:  May 2016 Investor Update, slide 3

Phillips 66’ fundamental data stands out.  The company has a price-to-earnings ratio of just 13.4.  It also has a well-above average dividend yield of 3.3%.

Additionally, the company has a long tradition of paying steady or increasing dividends.  Phillips 66 has paid steady or increasing dividends for 29 consecutive years, including its history as part of ConocoPhillips (COP).

These metrics help Phillips 66 to rank very highly using The 8 Rules of Dividend Investing.

Refining is Phillips 66’s largest business.  The refining industry is commoditized.  As a result, Phillips 66’s profits fluctuate with crack spreads.  The ‘crack spread’ is the spread that refiners make on processing oil.

Like most commoditized goods and services, crack spreads fluctuate.  They typically fall when oil prices rise and rise when oil prices fall.  It’s not the absolute price of oil that matters, but the change in oil prices that relates most to crack spreads.

A short-term decline in crack spreads doesn’t indicate a permanent loss in market position or competitive advantage for Phillips 66.

So what is Buffett doing investing in a commodity business?  Commodity businesses can be very successful when they are low cost producers.  As the largest business based on market cap in its industry, Phillips 66 has a size advantage over its peers.

Additionally, the company’s chemical segment has potential.  Phillips 66’s chemical operations are a joint parternship with Chevron (CVX).

Chevron is being crushed by low oil prices.  The company is selling assets to provide cash.  It is possible that Chevron sells its interest in its chemical operations to Phillips 66 – which would be a net win for Phillips 66.

Phillips 66’s chemical segment is the global low cost producer of ethylene.

Warren Burren, Phillips 66, Apple

Source:  August 2016 Investor Update Presentation, slide 13

Ethylene has many uses.  The majority of ethylene is used to make plastics.

Phillips 66’s management allocates capital intelligently.  The company pays a regular dividend and is repurchasing large amount of shares.  The company has reduced its share count by 5.3% a year from 2012 through 2015.

The company has a shareholder yield (dividends + share repurchases) of over 8% at current prices.  Total returns of 8% a year are likely greater than what the market in general will deliver over the next several years.  If Phillips 66 can grow its business at all investor returns will be even higher.

The company has a number of projects that will likely boost growth.  I expect Phillips 66 to grow by between 1% and 5% a year.  This growth combined with its shareholder yield gives investors expected total returns of 9% to 13% a year.

Berkshire Dividend Buy #2:  Apple

Berkshire purchased an additional 5.4 million shares of Apple in its latest quarter.  Apple now makes up 1.1% of Berkshire’s stock portfolio.

Berkshire holds more than 4 times as much Phillips 66 stock (based on market value) than it does Apple stock.

Buying Phillips 66 stock is likely a decision Buffett made himself.  The large percentage of Berkshire’s portfolio he has invested in Phillips 66 shows his conviction in the stock.

Berkshire’s smaller positions are likely investments from one of its two investment managers who manage smaller pieces of the company’s portfolio.  These two managers are Todd Combs and Ted Weschler.

Apple is the largest business in the world based on its market cap of $590 billion.

Apple has generated $47.8 billion in profits over the last 12 months.  Apple is in a league of its own based on profits (and what’s the point of business if not to make profits?).  The 2nd largest corporation in the world based on trailing twelve months profit is Berkshire Hathaway, with ‘just’ $25.5 billion in profits.

Apple is nearly twice as profitable as the second most profitable corporation in the world.  Think about that.

Despite its enormous profits, Apple trades for a low price-to-earnings ratio of 12.7.  The company has consistently hiked its dividend over the last several years, and now has an average dividend yield of 2.1%.  Apple has a payout ratio of just 24.7%.  Expect dividend growth to exceed earnings growth at Apple as the company continues its transition from a rapidly growing business to an established blue chip dividend paying corporation.

Growth has slowed tremendously at Apple.  This year (2016) is expected to be the first year of lower earnings for Apple since 2013.  The company has not grown much since 2012.  Profits in 2012 where $41.7 billion.  Nearly 4 full years later, and profits for the year are $47.8 billion.

Apple’s long-term prospects remain bright, however.  The company can continuously release new versions of the iPhone, iPad, and various Mac products.  The company’s service revenue grew 19% in its latest quarter, driven by increased app store revenue.  Apple’s rapid growth days are over.  It is a mathematical impossibility for any business to grow at 20% to 30% a year indefinitely.

The company can still reward shareholders with positive shareholder returns – especially at current low price-to-earnings levels – through a mix of share repurchases, dividends, and continued growth in service revenue in the medium term.

In the long-run, Apple’s longevity is unproven.  The iPhone was released in 2007, the iPad in 2010.  What will the smart phone and tablet landscape look like a decade from now?  How about in two decades?  The rate of change is only increasing.  Think how different the smartphone and tablet industry was just 10 years ago, let alone 20 years ago.


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