No savings? I’d use the Warren Buffett method to target big passive income

When it comes to dividends, Warren Buffett has put on a decades-long masterclass. His holding company, Berkshire Hathaway, has massive positions in world-class businesses like Apple, Coca-Cola, and Bank of America. Each one regularly pays Berkshire a dividend.

Indeed, Coca-Cola alone now pays Buffett’s firm nearly $800m per year in dividends. The Oracle of Omaha has not lifted a finger to reduce that position since he first started building it in the 1980s.

Now, that figure is way beyond what a humble individual investor like myself might ever hope to achieve. But I can still follow certain elements of Buffett’s investing methodology to build sizeable passive income.

Think long term

Buffett’s philosophy is underpinned by a long-term mindset. We can see this with that Coca-Cola position, which has been held for decades. His ideal holding period is “forever“.

One of my favourite Buffett quotes is: “Someone’s sitting in the shade today because someone planted a tree a long time ago.” A tree doesn’t appear overnight and neither will wealth for most of us.

But if I invest £500 a month and achieve an average 10% return, I’d end up with £1m in just under 30 years. That assumes I reinvest dividends to really fuel compounding and actually generate a 10% return.

Neither is guaranteed — dividends or that return — but it is a realistic target, in my eyes. Buffett’s long-term average is nearly double that!

Focus on really profitable businesses

A quick scan of Buffett’s portfolio reveals that nearly all the companies make plenty of profit. That’s obviously critical for passive income as I can’t rely on flimsy firms for reliable dividends.

One stock from my own portfolio that offers a truly massive dividend yield is British American Tobacco (LSE: BATS). Currently it sits at 8.6%.

Yesterday (25 July), the company reported that its half-year revenue fell 8.2% to £12.3bn, driven lower by the sale of its businesses in Russia and Belarus last year and foreign exchange headwinds. Profit slumped 28% to £4.26bn due to amortisation charges related to its US brands.

On the surface, none of that sounds great. And growth in its New Categories division, which houses smoke-free products like Vuse vapes and Velo nicotine pouches, is being hampered by the rise in illicit single-use vapes. So that’s an ongoing risk here.

Yet the company remains a high-margin, cash-generative business that owns leading cigarette brands like Dunhill and Lucky Strike. And its smokeless brands now account for 17.9% of group revenue, up from 16.5% in H1 2023.

To my eye, the meaty dividend yield looks sustainable, and that’s why I own the stock.

Taking a stance

Now, I should point out that while Buffett admires the economics of the tobacco industry, he doesn’t invest in tobacco stocks. Yet he does invest in oil stocks, with Chevron and Occidental Petroleum being two of Berkshire’s largest holdings.

Some investors won’t invest in either tobacco or oil for ethical reasons. And that’s fine, as every investor will ultimately draw their own lines.

Whatever these standards may be, though, I think focusing on very profitable companies with proven business models will lay a solid foundation for rising income and wealth. Time and consistency are the other things I need.