Since 2018, Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) stock has been in consolidation mode, which should pique the interest of long-term investors.
Long-term market-beating performance
Warren Buffett has been a great long-term investor and has generated excellent total returns over many years. From 1965 to 2018, BRK’s book value per share (“BVPS”) compounded at 18.7% per year, while the stock compounded at 20.5% per year, which more than doubled the S&P 500 total returns of 9.7% per year.
The Berkshire Advantage
The Top-Notch Insurance Operations
Berkshire’s well-run underlying insurance business generates float as a source of low-cost capital. In The Outsiders written by William N. Thorndike, Jr. that discusses “eight unconventional CEOs and their radically rational blueprint for success”, the author explained that
Over time, Buffett evolved an idiosyncratic strategy for his insurance operations that emphasized profitable underwriting and float generation over growth in premium revenue. This approach, wildly different from most other insurance companies, relied on a willingness to avoid underwriting insurance when pricing was low, even if short-term profitability might suffer, and, conversely, a propensity to write extraordinarily large amounts of business when prices were attractive. (Page 179)
How much do North Americans save every year? How much do you save and invest every year?
How many years will it take for you to get to $30,000 of dividend income?
The size of your current portfolio is, how much you contribute monthly, how much dividends you reinvest, and how much your income tax rate is will affect how long it takes.
How Much Does North Americans Save?
The latest data we found (from Jan. 2018) indicates the average Canadian earns CAD$55,806 in annual income, but the household savings rate was measly 1.1% in Q1 2019. That equates to tiny monthly savings of CAD$51.
Q4 2018 data indicates that the median annual income for an American was ~US$46,800, while the U.S. savings rate was recently 6-8% (US$234-312 per month), which is much better than in Canada.
Saving is a habit. The more you save now and invest it properly, the less you have to save for the future.
It’s not uncommon to save from 10% to 50% of one’s income. If the average Canadian or American can save just 15% of their income, that’d imply an amount of CAD$8,370 or US$7,020 that can be invested every year (or about CAD$700 or US$600 a month, respectively).
Since you have money to invest in stocks, obviously, you’re in much better financial shape than the average North American.
In the scenarios below, we assume you need $30,000 of dividend income (complemented by other income such as job’s income, rental income, or pension income) to live comfortably. Regardless of how much dividend income you need, the principles discussed will still be relevant.
Our other assumptions include a safe and conservative portfolio yield of 3% and a very achievable 10% rate of return on investments.
Scenario 1a: Starting with a $120,000 Portfolio
You currently have a portfolio value of $120,000
Annual growth of the portfolio is 10%, compounded annually
Monthly contribution: $0
Portfolio yields: 3%
Tax rate on dividends: 5.5%
Based on the assumptions above, it’ll take 23 years to earn $30,000 of annual dividend income. Notably, if we reinvested all the dividends received (after taxes), we would cut down 7 years and only take 16 years to earn $30,000 of dividend income.
Everyone’s tax rate is different. In our case, the Canadian province we reside in implies the highest tax bracket of 5.5% in 2019 if our only income were eligible Canadian dividends.
Obviously, if the tax rate were much higher, the dividends (after taxes) we get to invest will be so much lower, and it’ll take longer to achieve our dividend income goal. We just used the 5.5% as a conservative estimate, as the effective tax rate should be lower because the taxes for lower brackets are lower.
Annual Dividend based on 10% portfolio growth rate that assumes corresponding dividend growth:
Portfolio value with no dividend reinvested vs. Portfolio value with dividends reinvested
CVS Health (NYSE:CVS) was substantially undervalued before the 7% pop on Wednesday. It remains a strong buy for long-term investors.
Why the Pop?
CVS reported its Q2 results on Wednesday. And the stock appreciated 7% because the business performed better than expected with the company beating its own Q2 adjusted earnings per share (“EPS”) guidance by 10%. As a result, it also boosted its full-year guidance modestly by about 1.8% to $6.89-7.00.
Additionally, the Aetna integration and debt reduction have been progressing well.
Adjusted revenues increased 36% to $63.4 billion, adjusted operating income rising 55% to $4 billion, adjusted EPS rising 12% to $1.89, and cash flow from operations climbing 82% to $5.3 billion. The large spike in revenues and operating income is attributable to the Aetna acquisition, which was closed on November 28, 2018.
The Leveraged Balance Sheet
The Aetna acquisition resulted in CVS’s leveraged balance sheet. At the end of Q2, CVS’s net debt arrived at $61.3 billion, leading to a D/E of 99.6% and a debt-to-assets ratio of 28%.