Not all dividend shares are the same. And investors with a long-term view would be wise to pay attention to the differences between them.
Some of them have what billionaire investor Warren Buffett calls the ‘secret sauce’. And I think these are the ones that are worth paying particular attention to.
What is the secret sauce?
In the 2022 letter to Berkshire Hathaway shareholders, Buffett talked about the company’s investment in Coca-Cola (NYSE:KO). It’s been a huge success.
The dividends Berkshire receives from Coca-Cola have grown from $75m in 1994 to $776m this year. This is because the business has managed to grow.
While the firm paid dividends, it has also retained some of its earnings. Over the last 10 years, Coca-Cola has earned $17.32 per share and distributed $15.50 to shareholders.
Importantly, the company has managed to reinvest the cash it has retained at good rates of return. The firm’s return on equity (ROE) over the last decade has consistently been strong.
Coca-Cola return on equity 2014-24
Created at TradingView
This is the secret sauce – the ability to retain earnings and reinvest them while maintaining a high ROE. And there are a couple of FTSE 100 dividend shares that do this pretty well.
Diageo
It might not be much of a surprise that Diageo‘s (LSE:DGE) one example. In terms of scale and strong consumer brands, it has a similar profile to Coca-Cola.
An obvious risk with Diageo is that its products are subject to alcohol duty, which Coca-Cola isn’t. That’s an ongoing source of risk that investors pay careful attention to.
Over the last 10 years, the UK spirits business has generated £19.51 in earnings per share. And it has paid out £6.80 in dividends, while retaining the rest within the business.
Diageo return on equity 2014-24
Created at TradingView
While retaining most of its net income, Diageo’s managed to maintain a very strong return on equity. And that’s what Buffett identifies as key to Coca-Cola’s success.
BAE Systems
Another example is BAE Systems (LSE:BA.). The defence contractor’s a different type of business, but not all great stocks look the same.
With military equipment, there’s a risk of changing political relations impacting the firm’s ability to do business in certain countries. And the company can’t do much to offset this.
Nonetheless, the firm’s position in the fighter jet market’s helped it achieve good results. Since 2014, it has earned £3.91 per share since 2014 and paid out £2.30 in dividends.
BAE Systems return on equity 2014-24
Created at TradingView
BAE Systems has also managed to earn strong returns on equity while retaining its profits. It’s not quite in the same league as Diageo and Coca-Cola, but it’s still consistently ahead of the FTSE 100 average.
Outlook
Buffett’s had great success investing in dividend stocks that he can reinvest, retained earnings at good rates. And I think both Diageo and BAE Systems have this ability.
Past success doesn’t guarantee a good result in future. But I think both companies have durable competitive advantages, giving them a decent chance going forward.
This post was originally published on Motley Fool
