One of the most difficult aspects of generating a passive income is ensuring that it is sustainable over a long time period. Some companies, for example, may pay a generous dividend today, but could be unable to do so in future. This may be due to changes in their operating environment or financial difficulties.
Therefore, following the advice of Warren Buffett on economic moats could be a sound idea for income-seeking investors. Buffett has always focused his capital on businesses that enjoy a competitive advantage over their peers, which means their financial prospects may be more certain than those of most companies.
By investing in more reliable stocks that have resilient growth prospects, it may be possible to produce a higher passive income that proves to be more robust over the long run.
Of course, a company’s economic moat is highly subjective. There is no simple test that can be undertaken by an investor that identifies the likelihood that a specific business will be able to record sustainable profit and dividend growth over the long run.
However, by focusing on a company’s competitive position versus its peers, it may be possible for an investor to gauge how wide its economic moat could be. This may, for example, entail a consideration of the brand loyalty it enjoys compared to sector peers. A business that has a strong brand which has been popular for a long time period may enjoy higher margins and more resilient sales performance than its rivals.
Likewise, an industry with high entry barriers may offer greater sustainability when it comes to generating a passive income. And companies that have lower costs than their peers may be able to better survive challenging economic periods in order to produce stronger financial performances that lead to higher income returns for investors.
While the prospects for the stock market may seem to be uncertain at the present time, there appear to be a wide range of stocks in the FTSE 350 that offer wide economic moats. In many cases, they may be defensive businesses that have a long track record of resilient profit and dividend growth. However, there are also growth companies with exposure to emerging markets, where rising demand could enable them to produce brisk dividend growth that proves to be relatively robust over the coming years.
As such, now could be the right time to focus on the stock market to generate a passive income. The yields available are generally higher than for other mainstream assets such as bonds and cash. Furthermore, by utilising Warren Buffett’s consideration of economic moats, it may be possible to obtain a sustainable income that provides a degree of security for an investor who is seeking to generate a passive income over the long term.
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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.