Warren Buffett is a renowned American billionaire and one of the most successful investors in the world. He is often reffered to as ‘the Oracle of Omaha‘. He was the favourite student of Benjamin Graham, the father of value investing. In plain terms, Graham’s method involves spotting good, undervalued companies, buying them, and holding them forever.
What do I mean by ‘good‘ companies? Well, most importantly, they have to be profitable. This doesn’t just mean having high net profit margins. It also means a company should have a good track record of rising profits. Of course, this doesn’t guarantee the firm’s profitability will keep rising in the future. But at least it makes investing in such a company somewhat safer. Of course, dividend-paying companies have a big advantage over their peers that don’t pay dividends.
Then, a great business should also have a sound financial position. Having a large cash pile is vital. What’s more, a company should have many more assets than liabilities. It’s okay to have debts but they must be manageable. Checking a firm’s financial soundness is easy. It’s sometimes enough to just check its credit ratings. These reflect the cash and debt positions. The higher the credit rating, the better it is for the company’s investors. But it’s not enough to buy ‘sound‘ companies.
It’s also essential for sound companies to be undervalued. You can spot them out by looking at their price-to-earnings (P/E) and price-to-book (P/B) ratios.
Warren Buffett also authored the concept of an economic moat. This simply refers to a big competitive advantage. Imagine there are several pharmaceutical companies. One of them, company A, has many more patents than any of its rivals. So, company A has an economic moat and therefore a leading market position that’s important for an investor.
Top UK shares
When I look at many Footsie shares, it seems to me they aren’t great bargains at all. But just like Warren Buffett and my colleague Peter, I think many sound businesses will be worth buying after a major sell-off. I believe there’ll be one for many reasons. The most obvious one is a ‘no-deal’ Brexit, I think.
So, here are some of my top picks.
Unilever is one of the largest consumer goods companies in the world. It sells essential items, most notably food and personal care goods. The company enjoys economies of scale and operates in many coutries all over the world. What’s more, the multinational’s credit rating is investment grade. Unilever’s dividend yield is around 3% now, which is reasonable. The only bad thing I see is its P/E ratio, which is above 20. So, I’d be happy to buy the company’s shares after a pullback.
GlaxoSmithKline, a leading pharmaceutical company, doesn’t look overvalued right now. It’s trading at a P/E of 16, while its dividend yield is over 5%. It has a great product pipeline and enjoys an investment-grade credit rating. But at the same time I’d prefer to acquire it at an even lower price to get better returns.
But I’d also look through the Motley Fool’s excellent library for other investment ideas.