If I wanted to get wealthier over time but had limited funds, what would I do? I would invest in shares. But not any old shares. Instead, I would focus my search on identifying cheap shares in brilliant companies. Here is why.
Brilliant companies produce outsized results
What is an example of a brilliant company from an investment perspective? For me, a standout would be Apple.
It is no accident that Apple is, by far, the biggest holding of billionaire investor Warren Buffett’s firm Berkshire Hathaway. Buffett recognises a great business model when he sees one.
So what is so attractive about Apple? It operates in an area where there is already huge customer demand. Not only that, but I expect demand to keep growing over the long term.
Lots of other companies operate in that sector. But Apple is different. From its brand to an ecosystem spanning payments to media services, the company has a distinct position. That gives it a competitive advantage that it can turn into profits. Last year, the tech giant earned a staggering $99.8bn after tax. That shows the financial power of a strong business model.
Over the long term, a company like Apple can use that competitive strength to produce strong results time and again. That is not guaranteed. But when it happens, investors often boost the firm’s share price. Apple shares are worth more than seven times what they were a decade ago. Brilliant companies can reward investors not just with good returns – but with outstanding ones.
Hunting for cheap shares
However, identifying brilliant companies is only one part of Buffett’s investment philosophy. He also focuses on buying them at an attractive price.
Even the best company can make a bad investment if it is overpriced. That is why, when investing, I look to buy cheap shares.
That does not mean simply buying shares that have a low price. It involves an equation. How does the price compare to what I see as the value of the company?
Take Apple. I can now buy the tech firm’s shares for 27% cheaper than a year ago. In itself though, that does not make them cheap. Instead, I need to compare the current Apple share price to what I see as the firm’s long-term value.
How to value shares
There are different ways to value shares. For example, I could use the discounted cash flow valuation model. By estimating what I think Apple’s future cash flows may be, I could decide whether I think its current valuation is attractive.
If a company has brilliant prospects and an attractive share price, I can hopefully benefit no matter how much I invest. A smaller sum may mean a smaller gain – but I could still make money.
Even the best company can meet unexpected difficulties though. That is why I diversify my portfolio and £1,000 is enough to let me do that. I could invest £250 in the cheap shares of four different companies I think are brilliant and attractively priced. Hopefully, over the long term, that may help me build my wealth.
The post I’d invest £1,000 in cheap shares now to start building long-term wealth appeared first on The Motley Fool UK.
C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Apple. 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 2022