Warren Buffett, as most investors will know, invests primarily in the US. But the Sage of Omaha, as he’s known, has though invested in the UK before, notably in Tesco. He also seemed to back Kraft Heinz’s attempted purchase of Unilever back in 2017.
To many investors, especially those who focus on value, he’s one of the greatest investors that has ever lived.
So, what lessons can be gleaned from Buffett’s success? How can an ordinary investor build a portfolio of UK shares using his principles?
Warren Buffett’s margin of safety
The margin of safety has always been critical to Warren Buffett’s investment thinking and remain sstoday. It’s something that has stayed with him throughout his long and hugely successful investing career. The term was critical to the investment principles of his mentor Benjamin Graham, well known as a deep value investor. In short, it means investing in companies below their true worth.
The tricky part is finding companies like that. There are a few shortcuts I’d use if I wanted to find companies that have a margin of safety. The most obvious would be to use the P/E ratio. If it compares well to competitors and to the market as a whole, this could be a sign of value.
A low P/E in itself though isn’t enough. I would want to see lots of current assets, ideally cash as well on the balance sheet. This means the company should be able to pay its debts. I’d buy UK shares with current ratios (that is, current assets divided by current liabilities) of two or over.
Investing in great companies at a fair price
One of the biggest developments in Buffett’s investing journey was to go from picking the very cheapest companies with the widest margin of safety to picking high-quality companies when they were trading more cheaply. The change in approach is credited to his business partner, Charlie Munger.
I’d adopt this approach when it comes to building a portfolio of UK shares. It’s often possible to hear private investors saying “buy the dip”. It means buy when prices are falling. At the end of the day, investing comes down to the central idea of buying low and (eventually) selling high.
In practice, to do this can be tricky. To help me succeed I keep a list of stocks that I think fit the mould of being high quality. This involves having a competitive advantage, growing sales, high or improving margins, high returns on capital employed and being better run than other stock market listed competitors.
Then I set up price targets or buy orders. With my stockbrokers, I have orders automatically set up for when a stock hits a certain price. This will allow me to pick up the shares when they’re at a value I like. The risk here is I might pick up the shares just as they announce bad news.
Overall, to build a portfolio of UK shares with Warren Buffett’s advice and style in mind I would look to buy when there’s a margin of safety in the share price.
I would also focus on high-quality companies with a durable competitive advantage and then buy them at what I’d consider to be a fair price.
The post How to build a portfolio like Warren Buffett with UK shares appeared first on The Motley Fool UK.
Andy Ross owns no share mentioned. The Motley Fool UK has recommended Tesco. 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.
Motley Fool UK 2021