Buy These 2 Stocks Warren Buffett Calls "The Secret Sauce" to His Success

In his most recent letter to Berkshire Hathaway investors, Warren Buffett heralded the company's return of more than two million percent since its 1965 inception, and shed light on the investing philosophy that has driven those gains.

Offering readers what he called "a peek behind the curtain," Buffett said that the secret sauce for Berkshire's returns was companies that continue to raise their dividends year after year, "as certain as birthdays."

In particular, he singled out these three stocks as perpetually dividend-growing machines.

"Secret Sauce" Stock No. 1: Coca-Cola (KO)

In 1994, Buffett bought his last share of Coca-Cola stock, after staggering out his purchases over seven years.

The dividends he received from his entire position in 1994 amounted to $75 million. But by 2022, the annual dividends had increased to $704 million.

That's more than half of what Berkshire paid for its Coca-Cola shares—and KO has grown its dividend twice in the two years since, most recently with a 5.7% dividend increase last spring.

As Buffett recalled:

"Growth occurred every year, just as certain as birthdays. All Charlie and I were required to do was cash Coke's quarterly dividend checks. We expect that those checks are highly likely to grow."

"Secret Sauce" Stock No. 2: American Express (AXP)

In 1995, Berkshire Hathaway completed its purchase of American Express stock. Coincidentally, it invested the same amount that it had in Coca-Cola: $1.3 billion.

That year, AXP paid Berkshire Hathaway $41 million in dividends for their position. The dividend stream grew to $302 million a year in 2022, shortly before Buffett wrote his annual letter.

Buffett said at the time, "These checks, too, seem highly likely to increase."

The Oracle of Omaha was right about that. Last spring, AXP announced a healthy 17% dividend increase. Berkshire's annual income stream from those shares is now well over $350 million per year.

Is it too late to buy these stocks today?

The dividend growth of these two stars in Berkshire's portfolio is impressive, but alas, they are in the past.

To see if they can keep growing dividends, there are two metrics to examine.

The first is the payout ratio—the percentage of net income a company devotes to paying dividends.

The higher the payout ratio, the more tenuous the dividend growth—since the company is already devoting a large chunk of its resources to the dividend payout.

A smaller payout ratio, on the other hand, indicates plenty of room for growth, since the company can ramp up its dividend without growing earnings at all.

That said, earnings growth, the second metric to examine, certainly helps.

Coca-Cola's payout ratio of 77% is on the high side, and with its earnings growth falling last quarter, future dividend hikes are likely to be modest in the near term.

By contrast, American Express' earnings growth of 38% last quarter, combined with its low payout ratio of 19%, indicates the company could be set up for years of prodigious dividend growth ahead.

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