With hardly any savings at 40, I’d use the Warren Buffett method for generating passive income

When ASX investors think of passive income, dividends likely come to mind. Indeed, it may be difficult to think of another form of consistent passive income that can be garnered from shares, without selling them that is. That’s where legendary investor Warren Buffett comes in.

The multi-billionaire company Berkshire Hathaway Inc (NYSE: BRK.A)(NYSE: BRK.B) famously doesn’t pay dividends. And yet, it’s provided shareholders with plenty of passive income opportunities.

How, may you ask? Share buybacks.

If I were 40 with just enough savings to support myself in case of emergency, I would aim to invest in companies I believe likely to undergo share buybacks so as to create a passive income stream. Here’s how that could work.

Buffett backs share buybacks over dividends

Buffett told investors in 2004 he believes the best use for a company’s spare cash is often repurchasing its own shares.

By buying back shares, a company increases shareholders’ ownership. That’s because each share represents a portion of a business. Thus, the fewer shares are out there, the more of that business each share represents.

Speaking on the topic, Buffett said:

I think the best use of cash, if you don’t have a good use for it in the business, if the stock is under-priced, is to repurchase it.

He backed up that sentiment in later years when Berkshire Hathaway began to undergo its own share buybacks.

How can buybacks generate passive income?

As share buybacks are a tool to increase shareholders’ ownership over a company, they can allow an investor to incrementally sell their holdings without reducing their own ownership.

Here’s an example.

If I were to own a 10% stake in a company, and that company buys back 5% of its shares, I would suddenly hold 5% more of the business – 10.5% – without forking out more cash.

That means I could offload the extra 5% on the market, thereby creating a passive income, without impacting my position.

Thus, if I were 40 with hardly any savings, I would use Buffett’s wisdom to buy shares in companies I believe are likely to undergo share buybacks so as to receive passive income.

Of course, it’s worth noting that no company can be guaranteed to announce or continue a share buyback.

Many ASX 200 shares turned to buybacks in 2022

A swathe of broader market happenings saw many S&P/ASX 200 Index (ASX: XJO) shares turn to buybacks in 2022.

The largest was likely that undergone by Whitehaven Coal Ltd (ASX: WHC) – which interestingly also posted huge dividends last year.

It bought back 10% of its stock between March and October before committing to buy back another 25% of its outstanding shares over the following 12 months.  

National Australia Bank Ltd (ASX: NAB) also completed a $2.5 billion buyback in March before going again, announcing another of the same magnitude.

Other ASX 200 companies announcing share buybacks in 2022 included Qantas Airways Limited (ASX: QAN) and Santos Ltd (ASX: STO). The former kicked off a $400 million buyback while the latter announced US$700 million worth last year.

The post With hardly any savings at 40, I’d use the Warren Buffett method for generating passive income appeared first on The Motley Fool Australia.

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Motley Fool contributor Brooke Cooper has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Berkshire Hathaway. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has recommended the following options: long January 2023 $200 calls on Berkshire Hathaway, short January 2023 $200 puts on Berkshire Hathaway, and short January 2023 $265 calls on Berkshire Hathaway. The Motley Fool Australia has recommended Berkshire Hathaway. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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