Passive income is the holy grail for many investors, including myself. As such, income stocks are the backbone of my portfolio. These shares provide me with regular — although not guaranteed — dividend payments.
So, what can I learn from Warren Buffett to enhance my passive income generation? Let’s find out.
Value investing
Buffett is known for his value investing strategy. This is an approach involving picking stocks that appear to be trading for less than their intrinsic or book value.
Value stocks also tend to pay a dividend because they’re established companies that look to reward shareholders rather than focusing solely on growth.
The legendary American investor is renowned for buying stocks that are trading at a discount. But not stocks that just appear cheap. He’s looking for stocks that are meaningfully undervalued.
And finding stocks that are meaningfully undervalued requires plenty of research. It’s more than just looking at the price-to-earnings ratio. I’ve got to delve deeper.
Buying low
Buffett often searches for a margin of safety. And this means he wants the share price of the stock he’s buying to be considerably lower (30%-50%) than what he perceives to be the intrinsic value of the company.
It’s like buying-low-selling-high, but on a much more calculated basis and with the aim of holding long term rather than selling fast.
And when share prices fall, something interesting happens to the dividend yield. It goes up. So, buying stocks when they fall can provide me with the opportunity to obtain higher yields. After all, the yield I receive will always be relevant to the price I pay for the stock.
But what Buffett teaches us is to be careful of cheap stocks and big yields. I need to really do my research, and run tests like the discounted cash flow model, to see if I’m buying the correct stocks.
By investing in shares that are meaningfully undervalued at the time of purchase, I can hope to accentuate the long-term upward trend in the market. And if my chosen stocks perform well, I can also hope to see the dividend payment grow over time.
Why now?
UK stocks have fallen over the past 12 months. That might come as a surprise to some as the FTSE 100 is back at 7,500.
But in reality, large parts of the index have suffered, including banks, housebuilders and retail, while resource stocks have surged. Oil and mining stocks are disproportionately represented on the index.
Right now, I contend that there are a host of undervalued stocks on the index with strong and sustainable dividend yields that will boost my passive income generation.
I’ve recently bought Lloyds and Direct Line Group, among others, to enhance my income from dividend stocks.
And by doing my research, and applying Buffett’s teachings, I can hope to minimise risk and propel my portfolio forward.
