2 UK dividend shares with the Warren Buffett ‘secret sauce’

Warren Buffett says the best dividend shares are ones that can also reinvest their earnings at good rates. Which FTSE 100 stocks have this ability?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Warren Buffett at a Berkshire Hathaway AGM

Image source: The Motley Fool

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

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.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has positions in Berkshire Hathaway and Diageo Plc. The Motley Fool UK has recommended BAE Systems and Diageo Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Person holding magnifying glass over important document, reading the small print
Investing Articles

Just released: our top 3 small-cap stocks to consider buying in October [PREMIUM PICKS]

Small-cap shares tend to be more volatile than larger companies, so we suggest investors should look to build up a…

Read more »

Investing Articles

How I’d use an empty Stocks and Shares ISA to aim for a £1,000 monthly passive income

Here's how using a Stocks and Shares ISA really could help those of us who plan to invest for an…

Read more »

Investing Articles

This FTSE stock is up 20% and set for its best day ever! Time to buy?

This Fool takes a look at the half-year results from Burberry (LON:BRBY) to see if the struggling FTSE stock might…

Read more »

Investing Articles

This latest FTSE 100 dip could be an unmissable opportunity to pick up cut-price stocks

The FTSE 100 has pulled back with the government’s policy choices creating some negative sentiment. But this gives us a…

Read more »

A young woman sitting on a couch looking at a book in a quiet library space.
Investing Articles

As the WH Smith share price falls 4% on annual results, is it still worth considering?

WH Smith took a hit after this morning’s results left shareholders unimpressed. With the share price down 4%, Mark Hartley…

Read more »

Investing Articles

The Aviva share price just jumped 4.5% but still yields 7.02%! Time to buy?

A positive set of results has put fresh life into the Aviva share price. Harvey Jones says it offers bags…

Read more »

Investing Articles

Can a €500m buyback kickstart the Vodafone share price?

The Vodafone share price has been a loser for investors in recent years, and the dividend has been cut. We…

Read more »

Frustrated young white male looking disconsolate while sat on his sofa holding a beer
Growth Shares

3 mistakes I now avoid when choosing which growth stocks to buy

Jon Smith runs through some of the lessons he's learnt the hard way over the years about what to look…

Read more »