We all know that it takes money to make money, and Warren Buffett probably understands this old adage more than anyone. Directing available cash into assets that reliably generate passive income is how he turned a failing textile mill called Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) into a gigantic holding company that’s now worth nearly $600 billion.
Berkshire Hathaway doesn’t offer its shareholders a dividend, but investors seeking reliable income streams can ride on Buffett’s coattails by mimicking some of his biggest bets. Here’s what you want to know about two of the largest dividend-paying equity investments in Berkshire’s portfolio.
Buffett began aggressively acquiring Chevron (NYSE: CVX) before Russia, formerly the world’s largest oil exporter, incited severe sanctions against itself by invading Ukraine. Perhaps the first thing to know about oil producers is that, when the price of the commodity they produce rises, so do their cash flows. Now that oil prices are hovering over $115 per barrel, Chevron will have plenty of cash to dramatically raise a dividend that already offers a 3.8% yield at the moment.
During its investor-day presentation this March, Chevron laid out a couple of scenarios involving the average cost of oil through 2026. If prices hover around $50 per barrel from now through 2026, the company thinks cash from operations will be sufficient to cover capital expenditures and dividend payments. If oil prices average $75 over the same time frame, the company thinks it can meet the same obligations and buy back more than 25% of its outstanding shares.
When COVID-related lockdowns pulled the rug out from under oil prices in 2020, Chevron had to dip into its cash reserves to meet its dividend obligation. By the time Russia sanctions sent oil prices skyrocketing this February, Chevron’s bottom line was already firmly in positive territory.
Over the past 12 months, Chevron generated a whopping $24.78 billion in free cash flow, and this figure will probably rise sharply the next time the company reports. Dividend payments worked out to just 42.21% of free cash flow generated over the same time frame. With no end to sky-high oil prices in sight, Chevron can easily return buckets of cash to shareholders.
2. Bank of America
Buffett’s a big fan of Bank of America (NYSE: BAC) and banking stocks, in general. Dividend investors also flock to this industry because banks tend to generate reliable cash flows that they aren’t shy about sharing with investors as dividends.
Right now is an especially good time to buy bank stocks that are sensitive to interest-rate changes because the Federal Reserve is determined to stop inflation, even if it has to push rates up to a double-digit percentage.
Bank of America shares offer a 2.5% dividend yield at the moment, but this isn’t the reason it’s a particularly good bank stock to own now. The company is also highly sensitive to rate changes.
Bank of America recently reported first-quarter net interest income that rose 13.6% year over year to an annualized $46.4 billion. Investors can expect more dramatic rises in the quarters ahead. In April, management told investors that net interest income would rise by $5.4 billion if short- and long-term interest rates rise 1%, in parallel. The Federal Reserve recently hiked benchmark rates by 0.75% to a range between 1.50% and 1.75%, and it looks like more rate increases are around the corner.
Most members of the rate-setting committee expect the benchmark rate to finish the year at 3.4% or higher. If they’re right, Bank of America could end up raising dividend payments through the roof.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. Cory Renauer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.