Warren Buffett says you need to make passive income while sleeping.

View over Old Man Of Storr, Isle Of Skye, Scotland

Story by Zaven Boyrazian, CFA

Few investors come close to matching the exceptional track record of billionaire Warren Buffett. The ‘Oracle of Omaha’ has steered his investment firm to generate close to a 20% average annualised return since the 1960s. So it’s no surprise that when Buffett gives advice, investors listen… carefully.

And with the cost of living continuing to rise, his previous tips about the need to earn passive income are now more relevant than ever. After all, “If you don’t find a way to make money while you sleep, you will work until you die”, he famously said.

With that in mind, here’s how any investor can immediately start earning a passive income overnight.

The power of dividends

While many investment portfolios tend to be geared towards growth, it’s easy to overlook mature, boring dividend-paying stocks. After all, why would you invest in a dull self-storage enterprise when there are bleeding-edge biotechs curing cancer?

So how do investors tap into all this passive income potential? It’s simple. All they need to do is buy shares in a dividend-paying company, and wait for the money to come rolling in, usually once every quarter.

But is it really that simple?

Risk versus reward

The most lucrative dividend stocks over the long run aren’t necessarily the ones with the highest yields today. Instead, it’s the businesses that generate exorbitant volumes of consistent free cash flow that not only fund shareholder payouts but also enable them to grow over time.

That’s a lesson Buffett has learned firsthand with his investment in Coca-Cola (NYSE:KO). The soft drinks giant has used its consistent and steady cash flows to increase dividends every year for 63 years in a row. And consequently, Buffett’s now earning more than a 60% yield on his original investment in the late 1980s.

Sadly, past performance doesn’t guarantee future results. And if investors blindly buy previously successful income stocks without investigating the underlying risks or potential rewards, their passive income could quickly disappoint.

So let’s take a closer look at Coca-Cola.

Still worth considering?

Starting with the positives, Coca-Cola’s latest results show that the company continues to expand sales organically at impressive profit margins. And even after another round of price increases, thanks to the group’s brand driving pricing power, sales volumes have remained robust, indicating that customers are happy to pay a premium.

That all translates into yet more free cash flow, paving the way for its 64th consecutive dividend hike. However, there are some brewing headwinds to keep a close eye on. Rising global sugar taxes and rising economic constraints in key emerging markets undermine the group’s long-term momentum.

As such, even if dividends continue to rise, future payout hikes might be far less impressive. Put simply, there may be other better dividend growth opportunities to explore right now. Nevertheless, for investors seeking reliable passive income, this Buffett-style stock might be worth a closer look.

The post Warren Buffett says you need to make passive income while sleeping! appeared first on The Motley Fool UK.