Here is Warren Buffett’s method for building wealth over time
Dividend stocks are a great choice for investors looking for passive income. But when it comes to building wealth, Warren Buffett has a better strategy.
Warren Buffett knows the secret to building wealth. And while Berkshire Hathaway owns a number of dividend stocks, the Oracle of Omaha is clear that receiving dividends is not what has made him rich.
According to Buffett, what matters is not whether a company distributes its profits as dividends or not. Rather, it is the company’s ability to reinvest its earnings internally – in other words, its growth prospects.
Dividend shares
It is hard to see how Buffett’s success is not the result of dividends. Coca-Cola – a classic example of a dividend stock – is Berkshire’s fourth largest equity investment and one of Buffett’s most famous successes.
Do you like the idea of dividend income?
The prospect of investing in a company just once and then sitting back and watching it potentially pay dividends again and again?
If you’re excited by the idea of regular passive income payments, as well as the potential for significant growth on your initial investment,…
But, as Berkshire’s CEO explains in its latest letter to shareholders, the reason Coca-Cola has been such a good investment is that it has gradually increased its revenues. As Buffett puts it:
The cash dividend we received from Coke in 1994 was 75 million dollars. By 2022, the dividend had increased to $704 million. Growth occurred every year, as sure as birthdays. All Charlie and I had to do was cash Coke’s quarterly dividend checks.
Berkshire receives much more in dividends from Coca-Cola now than 28 years ago. But this is not the result of reinvesting dividends – Buffett has not invested more Berkshire’s Coca-Cola investment since 1994.
It is rather the result of Coca-Cola finding a way to make more money. This means that it can increase the amount it returns to shareholders, causing the value of the share to rise.
As Buffett points out, a similar investment in a stock that didn’t grow would only yield about $80 million for Berkshire today. Over time, the value of a growing business is enormous.
Growth stocks
When it comes to building wealth, growth stocks are Buffett’s clear preference. These are shares in companies whose priority is to find ways to increase their earnings per share.
Different companies pursue growth in different ways. Some want to develop their existing business, others aim to acquire new business, some use their money for share buybacks and some do a mixture of these.
For example, Halma and Diploma aim to both improve their existing operations and acquire new ones. And Rightmove looks set to increase its revenue while reducing its share count through share buybacks.
None of this means that growth stocks don’t pay dividends – Halma, Diploma and Rightmove all give money back to investors in this way. But their main priority is to increase their earnings per share over time.
As a result, growth stocks are generally not obvious choices for investors looking for passive income. They focus on adding value to their business, not on providing income to shareholders.
However, for investors who want to build wealth gradually, growth stocks are ideal. Their goal is to use the money they generate to make themselves worth more in the future than they are today.
Building prosperity
Warren Buffett’s approach to building wealth is to find companies with good growth prospects. With Coca-Cola, the amount Berkshire Hathaway receives in dividends has increased by over 800%.
It has nothing to do with reinvesting dividends or seizing an opportunity at a time when share prices were low. It is simply the result of the company finding a way to increase the value of its shares over time.
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