Warren Buffett’s holding company, Berkshire Hathaway, didn’t reach a market capitalization of nearly $700 billion by accident. Buffett meticulously selects each investment that makes it to the company’s portfolio.
And like us, he has a heavy focus on income.
So it may surprise you to learn Berkshire’s eighth-largest holding has a yield of only 0.96%.
That may sound like peanuts. But contrary to popular belief, stocks with dividend yields in the 1-2% range (or lower) often present the best opportunities to generate passive income and build significant wealth over the long term.
We recently recommended one such stock in our Intelligent Income Investor portfolio. And in today’s Daily essay, I’m going to walk you through the reason why.
I believe everyone should consider having at least one low dividend yield stock in their portfolio. It could be the one investment that shines when everything else falls.
But you don’t have to take my word for it. The most successful investor in the world has the same idea…
Learn from the Best
Let’s start by digging into the low-yield company the Oracle of Omaha selected for his Berkshire portfolio: Moody’s Corporation (MCO).
Moody’s serves as a foundational piece of the modern financial world. Its credit ratings are among the gold standard for any company attempting to tap debt markets and raise capital.
Moody’s has also posted double-digit earnings per share (EPS) growth in eight of the last 10 years.
Now, the company expects to report a tough year overall for its bottom line 2022. It couldn’t avoid the concerns of a recession hurting debt markets.
But it’s expected to bounce back quickly with consensus EPS growth rates for 2023, 2024, and 2025 of 13%, 20%, and 15%, respectively.
With that sort of expected bottom-line growth, the stock’s 0.96% yield doesn’t look so measly anymore.
Because thanks to its strong EPS growth, Moody’s has been able to produce a 13% five-year dividend growth rate. And even more impressively, 17% over the last decade.
So someone who bought shares a decade ago would be sitting on a yield on cost north of 10% right now.
And with similar dividend growth prospects moving forward, it won’t take long for today’s 1% yield to skyrocket to meaningful levels.
So how does this work?
There’s a multilayered relationship between fundamental growth, valuation premiums, and dividend growth. And sometimes, it can trick investors into value traps and dangerous yields.
Over time, the combination of rising fundamentals (sales, earnings-per-share, free cash flow, etc.) and the high valuation multiples applied to them results in higher and higher share prices.
And when we’re talking about dividend growth stocks with proven histories of returning cash to shareholders as a reliably increasing dividend, these higher-priced companies also produce safe and secure passive income.
Because of the inverse relationship between share prices and dividend yields, the high premiums associated with best-in-class companies mean low dividend yields.
That seems bad at first, but it’s actually a bit of a catch-22.
You see, the very high growth rates that drive yields down in the present also facilitate rapid dividend growth that is sustainable over time.
The compounding process associated with such rapid dividend growth means shareholders who buy into these stocks with miniscule dividend yields in the present… Don’t have to wait long for double-digit dividend growth to result in high yields on cost.
The key, as always, is buying them at a discount. Berkshire has amassed a portfolio full of these strong companies over the years, nearly all of which generate reliably increasing passive income.
And by focusing on the right companies at the right time, you can, too.
Don’t Miss Out
So where does that put us today? Glad you asked.
There’s a high-quality, low-yield stock I’ve had my eyes on that is currently trading at a discount. It’s posted positive year-over-year EPS growth every single year since becoming public and has compounded its dividend at a nearly 15% annual rate over the last 5 years.
I recommended it to our Intelligent Income Investor subscribers earlier this week.
So if you’re interested in learning more about this alternative blue chip in the financial services industry that offers a safe dividend with double-digit growth potential, then check out the Intelligent Income Investor here.
And for those who previously put their noses up at low-yield stocks: If you’re not a millionaire, it might be time to reevaluate your strategy for the sake of your portfolio’s bottom line.
Happy SWAN (sleep well at night) investing,
Editor, Intelligent Income Daily