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Saturday, July 13, 2013

How Buffett Collects a 50% Dividend Yield From Coca-Cola (KO)

Coca-Cola (Photo credit: Wikipedia)
By StreetAuthority

New York, Jul.13, stock watch .- Not many people know that Warren Buffett collects a 50% dividend yield on his shares of Coca-Cola (NYSE: KO). That's because it seems impossible. If you or I were to buy shares today, we'd earn a yield of less than 3%.

How does Buffett do it? Did he cut a behind-closed-doors deal with the legendary soft drink maker? Did he receive special dividends? To get a yield that high, you might even be tempted to think he did something unethical to get it.

But actually, it's none of the above. The answer is much simpler than you might think.

He uses a simple tool that many successful investors use. It's one you can use today to potentially earn yields as high as 10%, 20% or more on a handful of your investments in just a few years.

Let me show you how it works...

When most investors want a big dividend check, they look at stocks with the highest yields. They think bigger equals better.

To some extent they're right. Clearly, a higher dividend puts more cash in your pocket.

But you also need to consider a company's dividend growth -- and the likelihood it will continue that growth going forward. Given enough time, this can turn a lower-yielding stock into an even bigger income producer than some of the highest yielders on the market -- and with a lot less risk.

Savvy investors know this and use it to their advantage. When Buffett bought shares of Coca-Cola in 1988, it paid less than 8 cents per share annually in dividends, yielding a modest 4%. But since then the company has grown its dividend by an incredible 1,300%, giving Buffett more than a 50% yield on his original investment today.

Fortunately, thanks to the "dividend vault" phenomena -- which StreetAuthority co-founder Paul Tracy originally explained in this essay -- investors have a chance to do exactly what Buffett did -- earn outrageously large yields by owning solid companies with large cash hoards that will grow their dividends by a sizable amount over time.

Let me explain...

You see, starting from the financial crisis of 2007-2008, American corporations have been in a frenzy to hoard cash to protect their businesses from the worst. Over the five years following the crisis, many companies were still not seeing the demand that they wanted from consumers, so they just kept hoarding more cash.

Today, corporations in America hold close to a record $1.7 trillion worth of cash in the bank -- an amount larger than the GDP of 180 countries. Because the economy is still on uncertain ground, many of these companies will choose to only use a small amount of this cash to expand their business. Instead, they'll likely use most of it to reward shareholders in the form of dividends and share repurchases.

The companies most likely to do this are mature, steady growing businesses -- companies like Coca-Cola and Microsoft, for example. In fact, we've identified 13 companies that are likely to use their billion-dollar cash hoards -- or their own personal "dividend vaults" -- to reward shareholders.

We expect these "dividend vault" companies to be some of the fastest dividend growers on the market over the next 10 years. And that could easily lead to double-digit yields in just a few short years for investors who buy companies like these today.

Take "Dividend Vault" stock Cisco (Nasdaq: CSCO), for example. It has a $47 billion "vault" -- more than twice the size of Coca-Cola's cash reserves.

The $134 billion company practically dominates the routing and switching market, providing what is essentially the "backbone" of the Internet. And considering that global Internet and data traffic is projected to continue growing at a near-exponential rate in the coming years, the company stands to benefit from steady cash flows to keep adding to its "dividend vault."

But rather than just letting that money just sit there, Cisco has been rapidly increasing its dividend since it began paying one two years ago.

Since March 2011, Cisco has raised its quarterly dividend 183% -- from 6 cents per share to 17 cents per share. For investors who bought it then, that means a $1,000 annual dividend check has turned into $2,830 in a little more than two years.

If you bought shares today and the company kept growing its dividend at that pace, you would collect a 73% yield just five years from now.

To be realistic, it's unlikely that Cisco can keep raising its dividend by 90% every year, even with as much cash as it has saved. But even if the company increased its dividend by less than a third of that pace (with a more realistic 25% dividend growth rate) every year, look at what kind of yields you could collect after just holding onto your shares for a few years...

By 2018, you would collect a hefty 8.5% yield if you bought shares today. And in just 10 years from now, you would earn a 26% yield. In other words, by the 10th year, a $10,000 investment made today would throw off $2,600 worth of dividends in that year alone.

Now that's tall order for most companies. But it's not hard to imagine Cisco, with its $47 billion "dividend vault" and its stable, expanding business, growing its dividend by about 25% a year for the next few years.

Whatever the exact dividend yield ends up being, Cisco and the 12 other "Dividend Vault" stocks could grow their dividends for decades. And that could easily mean yields of 10%, 20% or more for investors willing to simply hold on and collect a growing stream of income from these stocks.

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