How To Compound Your Wealth like Warren Buffett

Updated on June 14th, 2022 by Bob Ciura

What happens when you push a small snowball down a hill… And what does this have to do with growing wealthy?

When you push a small snowball down a hill, it continuously picks up snow. When it reaches the bottom of the hill it is a giant snow boulder.

The snowball compounds during its travel down the hill. The bigger it gets, the more snow it packs on with each revolution. The snowball effect is a metaphor for compounding. It explains how small actions carried out over time can lead to big results.

In the same way, investing in high-quality dividend growth stocks can generate large amounts of dividend income over long periods of time. Investors looking for the best dividend growth stocks should consider the Dividend Aristocrats, a group of 65 stocks in the S&P 500 with 25+ consecutive years of dividend growth.

You can download an Excel spreadsheet of all 65 (with metrics that matter such as dividend yields and price-to-earnings ratios) by clicking the link below:

 

This article shows how to harness the power of the snowball effect to multiply your wealth and income many times over.

It also includes 5 real world examples of the ‘snowball effect’ stocks that have compounded investor wealth.

Table of Contents

You can instantly jump to any specific section by clicking on the links below:

The Power of The Snowball Effect

Before we discuss how to harness the power of the snowball effect we must understand the power of compounding.

The snowball metaphor visually shows the power of compounding.

“The most powerful force in the world is compound interest”
Attributed to Albert Einstein

Here’s the power of compound interest:

Imagine you invested $1 that compounded at 1% a day. In 5 years your $1 would grow to over $77 million. You would be the richest person in the world by year 7.

Keep in mind that compounding is not a get rich quick scheme. It takes time – and lots of it. There are no investments that compound at 1% a day in the real world.

The stock market has compounded wealth (adjusting for inflation) at ~7.1% a year over the long run. At this rate an investment in the stock market has historically doubled every 10.1 years.

It takes more time to compound wealth in the real world – but that doesn’t make the principles of compounding any less powerful.

Take Warren Buffett as an example. Warren Buffett is worth over $100 billion. Warren Buffett’s wealth comes from the tremendous benefits of the snowball effect through time.

Buffett Compound Interest

Warren Buffett compounded his wealth through a specific type of investment.

Specifically, Buffett invests in:

  1. Shareholder-friendly businesses
  2. With strong competitive advantages
  3. Trading at fair or better prices

“All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.”
Warren Buffett

The next section of this article discusses how to harness the power of the snowball effect by investing in the same type of businesses Warren Buffett does.

 

How You Can Harness The Snowball Effect

You can harness the power of the snowball effect by investing in the same type of businesses that have made Warren Buffett so wealthy over time.

Looking at Berkshare Hathaway’s portfolio, its top 5 stocks (as of its most recent 13F filing) make up 74.7% of the portfolio:

  • 42.09% is invested in Apple Inc. (AAPL)
  • 11.26% is invested in Bank of America (BAC)
  • 7.67% is invested in American Express (AXP)
  • 7.01% is invested in Chevron Corporation (CVX)
  • 6.71% is invested in Cola-Cola (KO)

These 5 Warren Buffett stocks represent a compounding machine. Do you know what’s interesting about these 5 business?

All 5 are well-established businesses that pay dividends.

  • Apple has a 0.7% dividend yield
  • Bank of America has a 2.7% dividend yield
  • American Express has a 1.4% dividend yield
  • Chevron has a 3.4% dividend yield
  • Coca-Cola has a 3.0% dividend yield

The average dividend yield of Berkshire Hathaway’s top 5 stocks is 2.2%. Warren Buffett holds a concentrated portfolio of businesses with above-average dividend yields and long histories of dividend payments to shareholders.

Related: How Many Stocks Should You Hold In Your Portfolio?

Investing in this type of business is the surest way to benefit from the snowball effect.

The good news is you don’t even have to search for these businesses. There is a list of 44 businesses with 50+ years of consecutive dividend increases called the Dividend Kings list.

Nothing says long-term success like 50 or more years of paying rising dividends in a row.

Coca-Cola (one of Buffett’s biggest investments) is a Dividend King. There are many other well-known stocks in the Dividend Kings list, including:

You may read this and think: “these businesses may have a history of success, but isn’t their run over”?

Investors have wasted tremendous sums of money chasing ‘the new hot stock’. You cannot benefit from the snowball effect by investing in businesses that are unproven. Steady dependable results lead to wealth multiplication.

What would happen if you had invested in some of the most well-known Dividend Kings in 1990?

The 7 example businesses below all had 25+ years of consecutive dividend increases by the end of 1990. They were well-known, blue-chip stocks in 1990.

It didn’t take a genius to buy and hold them…

But the results speak for themselves. Five examples of the snowball effect in action are below. All examples assume dividends were reinvested.

Example #1: The Coca-Cola Company (KO)

Coca-Cola compounded investor wealth at over 14% a year (including dividends) over the last 30 years. Coca-Cola was the largest soda brand in the United States in 1990… And had a 98 year operating history at the time. It was not a start-up.

Coca-Cola stock ended 1991 at a share price of $4.94 per share, adjusted for splits and reinvested dividends. The stock closed at $58.76 per share on December 31st, 2021. That means the stock generated annualized returns of 8.6% per year over the 30-year period from 1991-2021.

Example #2: Lowe’s Companies (LOW)

Lowe’s is the second-largest home improvement store in the United States, behind only The Home Depot (HD). In 1991 Lowe’s was one of the largest home improvement stores in the United States. It had a dividend history of over 25 consecutive years of increases even then.

Investors in Lowe’s 30 years ago have done very well

Lowe’s ended 2021 trading at an adjusted price of $256.59. With an adjusted price of $0.76 to end 1991 (accounting for stock splits and reinvested dividends), Lowe’s stock delivered compound annual returns of 21% per year over the past 30 years.

This means a $1,000 investment 30 years ago would be worth just over $336,000 to begin 2022.

Example #3: Procter & Gamble (PG)

Procter & Gamble was just as well-known in 1990 as it is today. The company has an iconic brand portfolio with names like Tide, Bounty, Gillette, and Charmin (among many others).

The company was founded in 1837. In 1990, Procter & Gamble had been around for 153 years… Not exactly a young company.

Still, long-term investors in Procter & Gamble have done well. The stock has produced 30-year annualized total returns of 11.9% a year.

Example #4: Colgate-Palmolive (CL)

Colgate-Palmolive traces its history back to 1806. Both the Colgate and Palmolive brands are easily recognized.

In addition to these brands, Colgate-Palmolive owns the Speed Stick, Soft Soap, and Hill’s brands (among many others).

Colgate-Palmolive has paid dividends since 1893. The company has paid increasing dividends for over 50 consecutive years. In 1991 the company had a streak of 28 consecutive dividend increases.

How did 1991 investors do?

Colgate-Palmolive generated a compound annual returns of 11.5% during this 30-year period.

Example #5: Johnson & Johnson (JNJ)

Johnson & Johnson is currently the largest health care corporation in the world. The company is one of the most stable businesses in the world as well.

This stability is reflected in Johnson & Johnson’s long history of dividend payments to shareholders. This ‘slow and steady’ business has been a boon for shareholders over the long-run.

The company generated compound returns of 11.2% a year for shareholders during this time period.

The company’s low stock price volatility only adds to its appeal. Investors have historically generated excellent returns with Johnson & Johnson stock without as many gut-wrenching ups and downs as compared to other stocks.

Snowball-Effect Stocks For The Next 25 Years

All 5 examples above trounced the market despite being well established businesses with long dividend histories.

But…

What stocks will be the next snowball effect compounders?

There’s no need to reinvent the wheel. Anyone holding the serial compounders above should continue to do so.

For those looking to enter into new positions in snowball effect stocks should look for the following:

  1. Above average dividend yield
  2. Below average price-to-earnings ratio
  3. Long dividend history

The biggest constraint of the 3 is the long dividend history. We will start by selecting only from the Dividend Aristocrats List.

To be a Dividend Aristocrat a stock must have 25+ years of consecutive dividend payments and be in the S&P 500. There are currently 65 stocks that match this criteria.

Out of the 65 Dividend Aristocrats, we will screen for:

  1. A dividend yield above the S&P 500’s 1.7% yield
  2. A price-to-earnings below the S&P 500’s ratio of 18.8

We will then sort these by expected total return. Total return is the expected earnings-per-share growth rate, plus the current dividend yield, as well as the net impact of any positive or negative changes in the price-to-earnings multiple.

The 10 highest expected total return Dividend Aristocrats with above market dividend yields and below market price-to-earnings ratios are listed below:

  • Stanley Black & Decker (SWK): Expected return of 19.9%
  • V.F. Corp (VFC): Expected return of 17.1%
  • 3M Company (MMM): Expected return of 17.0%
  • Lowe’s Companies (LOW): Expected return of 15.3%
  • T. Rowe Price Group (TROW): Expected return of 14.8%
  • Target Corporation (TGT): Expected return of 14.7%
  • Walgreens Boots Alliance (WBA): Expected return of 14.5%
  • Pentair plc (PNR): Expected return of 14.3%
  • Franklin Resources (BEN): Expected return of 14.2%
  • Leggett & Platt (LEG): Expected return of 12.2%

The 10 stocks listed above best match the criteria to best take advantage of the snowball effect.

‘Snowball stocks’ have strong and durable competitive advantages. Evidence of their competitive advantages is seen by their long operating history and consistent dividend increases.

Long-term investing in great businesses with shareholder-friendly managements at fair or better prices will very likely produce compound wealth gains over time.

Related: The video below discusses long-term investing and wealth creation.

Remember the snowball effect when choosing your investments.

Other Dividend Lists

The Dividend Aristocrats list is not the only way to quickly screen for stocks that regularly pay rising dividends.

Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected]


Ben Reynolds

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