How to invest using Warren Buffett’s ‘secret sauce’

You don’t have to be as good a stock picker as Warren Buffett to take advantage of dividend-paying stocks.

That’s good to know, since in his latest annual report, which was released late last week, Buffett


credited his success with dividend-paying stocks to a “secret sauce.” His comments might scare you away from thinking you can yourself perform admirably with dividend-paying stocks.

Read: Warren Buffett wants you to visualize Berkshire Hathaway’s tax bill. Get out your binoculars.

That would be a shame, since even the average company’s dividends per share have tended to grow faster than inflation. So even if you’re not another Warren Buffett, and instead are no better than average at picking stocks, odds are good that the dividends you receive from a diversified portfolio of dividend-paying stocks will grow faster than inflation.

The historical data are widely known, but still worth reviewing. Over the last 100 years, the S&P 500’s

dividends per share (DPS) have grown at a 5.0% annualized clip, versus 2.9% for the Consumer Price Index. Furthermore, as you can see from the accompanying chart, DPS’ advantage over the CPI has been particularly strong recently. Over the last decade, DPS’ growth rate has been 5.3 annualized percentage points ahead of inflation.

As you can also see from the chart, the growth rate of the S&P 500’s dividends per share has been highly correlated with the CPI’s growth rate. This provides confidence that, if and when inflation heats up in future years, dividend-paying stocks’ dividends will growth rate will accelerate.

The news isn’t just favorable for dividends. The price-only performance of dividend-paying stocks has also been better than inflation. Over the last century, in fact, the S&P 500 on a price-only basis has risen at a 3.3% annualized rate above inflation. In other words, dividend-paying stocks have provided a yield that grows faster than inflation while also providing growth potential in the underlying shares themselves.

Despite these strong historical precedents, dividend-stock strategies aren’t as popular as you might otherwise think. That’s because, to take advantage of them, you must hold for the very long term, and many—if not most—investors are too impatient. Buffett famously once said that his favorite holding period is “forever,” which is a far cry from what’s common on Wall Street, where—as the joke goes—the long term lasts from lunch until dinner.

Consider the S&P 500 Dividend Aristocrats ETF
which contains stocks of those companies within the S&P 500 that have increased dividends every year for the last 25 consecutive years. Over the last five years, the ETF has essentially equaled the broad market, producing a 9.6% annualized total return versus 9.5% for the S&P 500. Since the end of 1989, however, which is when the index to which the Dividend Aristocrats ETF is benchmarked was created, it has beaten the S&P 500 by 1.9 annualized percentage points.

This need to focus on the long term is also evident from the S&P 500 Dividend Aristocrats ETF’s current yield, which is just 2.05%. That’s less than half the 4.7% yield you can get from 1-month T-Bills, and a third the CPI’s rate of change over the last 12 months of 6.3%. But the cash dividends this ETF pays will almost certainly grow in coming years, and inflation is almost certainly going to be coming down: For example, the Cleveland Federal Reserve’s inflation expectations model projects the CPI will average 2.1% over the next decade.

Therefore, if you hold on long enough, your dividend income will most likely grow at an average rate that is faster than inflation. And your stocks’ high yields will eventually attract investors who will bid up the prices of those stocks. As Buffett said in his latest report: Dividend gains “being with them important gains in stock prices.”

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at