Warren Buffett’s portfolio of businesses generates billions of dollars in passive income every year. I am trying to replicate his approach by investing in companies that I believe the Oracle of Omaha would be interested in himself.
He rarely invests outside of his home market. However, just before the financial crisis, he offered to buy one UK corporation that was part of RBS (now NatWest)at the time.
According to reports, Buffett offered to buy Direct Line (LSE: DLG) from its parent for more than £5bn. This suggests that the investor saw a lot of similarities between this group and the insurance businesses his company owns in the US.
It also suggests that this is the kind of company he would be happy to buy as a passive income investment.
Warren Buffett-style investment
Direct Line has many of the qualities the Oracle of Omaha looks for in an investment. Its brand is well-known in the marketplace, and by selling directly to consumers, it also has a cost advantage over the competition.
On top of these factors, the business has exhibited disciplined underwriting standards in the past. Put simply, the company will only offer an insurance policy to a customer when it believes it can make money. It is not willing to chase customers just for the sake of gaining their business.
Some investors may not agree with this strategy. It does mean that the corporation will forego business for the sake of remaining profitable. Its growth could be underwhelming in the long run as a result.
Still, what the enterprise lacks in growth potential, it more than makes up for in income. Its profit generation allows management to return significant amounts of cash to investors. This is why I have been buying the company for my portfolio as a passive income investment over the past year.
At the time of writing, the stock supports a dividend yield of 8.1%. The company is also returning cash to investors by repurchasing shares.
Passive income offering
These are desirable qualities, but the company’s income should not be taken for granted. Even though the business prioritises profit generation over growth, it could still be surprised if there is a sudden increase in claims volumes. Such a scenario could throw the firm’s careful calculations out of the window.
Inflationary pressures may also hit profit margins as the cost of repairing vehicles rises, although the corporation is trying to offset some of these pressures by opening its own garages.
Warren Buffett was interested in Direct Line before the financial crisis. Over the past decade-and-a-half, the company has shown why.
It has several competitive advantages and is incredibly cash generative. As a passive income investment, I think this is one of the best opportunities for me on the market today.
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Rupert Hargreaves owns Direct Line Insurance. The Motley Fool UK has no position in any of the shares mentioned. 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.
