Buffett Made Billions on These Stocks -- but Here's Why He Really Likes Them

By Danny Vena Markets Fool.com

When it comes to investing advice, arguably no one commands more attention than Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) Warren Buffett. The company's annual shareholder letter is legendary and is probably the most widely read of its kind among stock enthusiasts. Market followers pore over any changes in Berkshire's portfolio of equity holdings and parse Buffett's words for insight into the fabled investor's decision-making and mindset.

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Berkshire's 2016 shareholder letter was no different and contains a list of the stock investments the company held at year's end that had the highest market values. A review of those investments revealed several stocks that have been multibillion-dollar winners for Buffett:

Company

Number of Shares

Cost Basis

Market Value (As of 12/31/16)

Gain

The Coca-Cola Company

400,000,000

$1.3 billion

$16.5 billion

$15.3 billion

Wells Fargo & Company

500,000,000

$12.7 billion

$27.6 billion

$14.8 billion

American Express Company

151,610,700

$1.3 billion

$11.2 billion

$9.9 billion

Data sources: author calculations and Berkshire Hathaway 2016 shareholder letter.

With those types of gains, you'd be tempted to think this alone would be a sufficient reason for the Oracle of Omaha to love these stocks. Sure, billions in gains would make anybody happy. However, there's another compelling reason Buffett likes these stocks -- they're dividend payers. In fact, given a choice, the legendary investor would take dividends, dollar for dollar, over capital gains.

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Surprised? In the 2016 shareholder letter, Buffett makes a compelling argument for why he likes dividends better:

Berkshire, like most corporations, nets considerably more from a dollar of dividends than it reaps from a dollar of capital gains. That will probably surprise those of our shareholders who are accustomed to thinking of capital gains as the route to tax-favored returns.

But here's the corporate math. Every $1 of capital ... carries with it $0.35 of federal income tax (and often state income tax as well). The tax on dividends received from domestic corporations, however, is consistently lower.

... For a non-insurance company -- which describes Berkshire Hathaway, the parent -- the federal tax rate is effectively $0.105 per $1 of dividends received.

... And that's our tax lesson for today.

He also explains how the tax rate on dividends received from The Kraft Heinz Companyis even lower at $0.07 per $1 of dividends, because of Berkshire's 20%-plus ownership of the company. The rationale behind this lower rate is that Kraft Heinz has already paid corporate taxes on the dividends being distributed. Given the favorable tax treatment of these dividend holders, it's easy to see why Buffett prefers dividends to capital gains.

Company

Number of Shares

Approximate Annual Dividend Payout (As of 12/31/16 Data)

The Coca-Cola Company

400,000,000

$592 million

Wells Fargo & Company

500,000,000

$760 million

American Express Company

151,610,700

$194 million

Data source: Author calculations and Berkshire Hathaway 2016 shareholder letter.

Individual investors can also benefit from knowing when they're subject to favorable tax treatment. Such is the case for capital gains, which are classified as either long or short term depending on the length of time held. When stocks are held for longer than one year, they're taxed at the long-term capital gains rate, which is capped at a maximum of 15% for most taxpayers. For those in the 10% or 15% ordinary income-tax brackets, the tax rate is 0%. Qualified dividends receive the same preferential tax treatment. Short-term capital gains, on the other hand, are taxed at a taxpayer's higher ordinary tax rate, which can be as high as 39.6%.

A dollar is a dollar, but not every dollar is taxed the same. It's in the investor's best interest to understand how and when favorable tax treatment applies, so that that investor can take advantage of them if the situation dictates.

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Danny Vena has the following options: short January 2018 $145 puts on Berkshire Hathaway (B shares), long January 2018 $145 calls on Berkshire Hathaway (B shares), and long January 2018 $45 calls on Wells Fargo. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.