Image source: The Motley Fool
Not all dividend shares are the same. And long-term investors would be wise to pay attention to the differences between them.
Some of them have what billionaire investor Warren Buffett calls the 'secret sauce'. And I think these are the ones that deserve special attention.
What's the secret sauce?
In the letter of 2022 to Berkshire Hathaway shareholders, Buffett talked about the company's investment Coca-Cola (NYSE:KO). It was a great success.
Berkshire's profits from Coca-Cola have grown from $75m in 1994 to $776m this year. This is because the business has been able to grow.
While the company pays dividends, it also retains some of its profits. Over the past 10 years, Coca-Cola earned $17.32 per share and distributed $15.50 to shareholders.
Importantly, the company was able to reinvest the cash it had saved with good rates of return. The company's return on equity (ROE) over the past decade has been steady.
Coca-Cola returns on equity 2014-24
Created in TradingView
This is the secret sauce – the ability to retain income and reinvest it while maintaining a high ROE. And there are several FTSE 100 dividend shares do this very well.
Diageo
That won't surprise us Diageo's (LSE:DGE) is one example. In terms of consumer durables, it has a similar profile to Coca-Cola.
An obvious risk with Diageo is that its products are subject to alcohol liability, which Coca-Cola is not. That is a constant source of risk that investors pay close attention to.
Over the last 10 years, the UK spirits business generated £19.51 in earnings per share. It also paid out £6.80 in dividends, while keeping the rest within the business.
Diageo return on equity 2014-24
Created in TradingView
While retaining most of its earnings, Diageo has managed to maintain a strong return on equity. And that's what Buffett points to as the key to Coca-Cola's success.
BAE Systems
Another example is this BAE Systems (LSE: BA.). A defense contractor is a unique type of business, but not all good stocks are created equal.
With military assets, there is a risk of changing political relations affecting the firm's ability to do business in certain countries. And the company can't do much to fix this.
However, the company's position in the combat aircraft market helped it achieve good results. Since 2014, it has earned £3.91 per share since 2014 and paid out £2.30 in dividends.
BAE Systems return on equity 2014-24
Created in TradingView
BAE Systems also managed to achieve strong returns on trading while maintaining its profitability. It's not in the same league as Diageo and Coca-Cola, but it remains ahead of the FTSE 100 average.
Outlook
Buffett has had great success investing in equity stocks that he can reinvest, keeping earnings at good rates. And I think both Diageo and BAE Systems have this capability.
Past success does not guarantee a good result in the future. But I think both companies have long-lasting competitive advantages, which give them a good chance going forward.
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