Warren Buffett is widely considered to be the best investor that ever lived. He owns hundreds of billions of dollars of stocks and shares in his investment conglomerate, Berkshire Hathaway. These investments produce billions of dollars in passive income every year for the company, although Berkshire itself does not pay a dividend directly to its investors.
Buffett is not a dividend investor. He has never said that he is specifically looking for high dividend stocks when he invests. Instead, Buffett, who is sometimes known as the Oracle of Omaha, is looking for the market’s best companies. Income is just a side effect.
The Warren Buffett income strategy
Buffett likes to target companies that produce high returns on their capital investments. These high returns can be an indication that the businesses have a solid competitive advantage. They also allow the organisations to return significant amounts of money to shareholders.
Put simply, Buffett is not looking for high dividend stocks, but he is looking for companies that can return a lot of money to investors. And when he buys securities, he does so with the view of holding them forever. If these companies progressively increase their dividends year after year, they can become high-yield investments.
The most famous example is Coca-Cola. Buffett started buying this stock in 1988. He paid an average price of $3.25 for the shares, almost all of which he still holds to this day. At the time, the stock was not considered a high-yield investment, but after 33 years, Coke’s annual dividend has risen to $1.68 per share. Buffett is now earning a 52% yield on the cost of his investment.
I am replicating the same strategy for my investment portfolio. I am concentrating on buying high-quality companies for my portfolio that have the potential to be able to grow their dividends steadily over the next few decades. A great example is the pharmaceutical group Hikma. I believe this company has the potential to increase its dividend steadily every year for the next decade or so.
Passive income growth
By using the strategy, I believe I can generate a passive income from my portfolio that is enough to live off. However, I am aware it will take time to hit this benchmark. That is why I am in no rush.
One of the downsides of investing in high dividend stocks is the fact that a high yield can be a sign that the market does not believe the payout is sustainable. A dividend cut could have a significant impact on my passive income strategy.
This is why I prefer the Warren Buffett approach, although it does have some pitfalls. Trying to predict which companies will be dividend champions 10 years or more from now is challenging. There is no guarantee I will ever get it right. If I do not, I will be ignoring high-yield stocks today for the potential returns that may never come.
As such, this passive income strategy may not be suitable for all investors. Still, I think it is an excellent approach to employ for my portfolio.
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Rupert Hargreaves owns shares of Berkshire Hathaway (B shares). The Motley Fool UK has recommended Hikma Pharmaceuticals. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.