Earning some extra money each month from dividend shares appeals to me. It clearly also appeals to legendary investor Warren Buffett, who has amassed a fortune over the years by buying dividend shares.
With a more modest goal of £700 each month in passive income, could I use some of Buffett’s wisdom to help build my own passive income streams? I think I can.
Learn how to read company accounts
If I stop by a Greggs or a Marston’s pub and notice that it is consistently busy, ought I to invest?
Getting firsthand experience of a business can be helpful to an investor. But whether a business is popular does not necessarily indicate how good an investment it could make. Lots of factors go into that, from long-term customer demand to its debt load. Even a great business can make a poor investment if its shares are too expensive.
That is why I think it is important to read company accounts. Doing so can help me understand the financial shape a company is in and how it plans to make money in future.
In 2008, when Buffett was weighing up investing a huge sum in the doomed bank Lehman Brothers, that is exactly what he did. He sat in his office one evening and read the firm’s publicly available annual report page by page. Based on that, he decide not to invest.
Buffett spends most of his working day reading. Company accounts are a vital tool to become a more effective investor.
Warren Buffett loves blue-chip shares
Occasionally, Buffett invests in a fairly young company in an unproven industry, like when he invested in electric vehicle maker BYD.
But in general, the ‘Sage of Omaha’ focusses squarely on large, blue-chip firms in well-established industries. He does not try to boost his dividend income by investing in exotic companies few people have heard of, or getting into tiny businesses hoping for explosive growth.
Instead, he reckons that if a company with a proven competitive advantage can keep doing well in a resilient industry, it ought to be able to throw off profits. Those can be paid out as dividends.
Quality over yield
If I wanted to earn £700 a month from dividend shares, that would add up to £8,400 a year. To target that, I could invest £84,000 in shares with an average yield of 10%. I would need to invest twice as much if my portfolio yielded an average of 5%.
What should I do? I would follow Buffett’s approach, which is always to focus on finding great businesses selling at an attractive price. He is never led by yield. Instead, he decides whether a company has strong prospects and is trading at a price that offers him value.
Even when trying to boost my dividend income, I would follow Buffett in this approach. First I would focus on finding the sorts of companies I want to own, trading at the right kind of price. Only then would I consider how their dividends could help me achieve my target and the sum I would need to invest to do that.
