Warren Buffett is famous for his outstanding track record in investing, By learning his simple approach to assessing shares, investors hope to be able to improve their own success rate in the stock market.
Below I explain one key thing Buffett looks for when assessing companies, and then identify a couple of leading FTSE 100 shares I’d buy using that method.
A moat helps keep protect a company’s business
In olden times, castles had moats to help repel attackers. It took more effort to attack a castle surrounded by a muddy pool of water. That reduced the chance that a building with a moat would be overrun by enemy soldiers.
The same is true for companies. That is why Buffett tries to choose businesses with a commercial “moat” – something which makes it harder for competitors to move into the same business space. For example, Buffett has a big holding in Coca Cola, whose unique formulation provides a protective moat. Similarly, he holds American Express, whose brand and service network is impossible for competitors to replicate.
Special recipes and brand names
Some leading British companies are attractive to me precisely because they have the sort of moat that appeals to Buffett.
One example is Diageo (LSE: DGE). Like Coca Cola, this drinks company has a lot of proprietary drinks recipes, such as its Johnnie Walker whisky blends and Guinness beer brand. These are impossible for competitors to replicate exactly.
In an age of globalised drinks brands, the company’s extensive distribution network further widens its moat. Diageo already sells into bars and restaurants, so the cost of adding in extra drinks brands is minimal. But for a single distillery or brewery with a limited range, getting distribution in new outlets could be cripplingly expensive.
Diageo clearly recognizes the advantage this portfolio strategy gives it. That is why it continues to acquire brands, such as its recent purchase of gin distiller Chase. Its shares have started to pick up again, but I would still buy Diageo for its moat.
A lesser known company I would also buy for the sort of moat Warren Buffett discusses is the logistics specialist DCC (LSE: DCC). Like Diageo, one element of its business moat is a distribution network. The company operates oil and gas retail networks throughout Europe and North America. In many areas, there is a stable repeat customer base for products like liquid propane gas (LPG).
The costs to entry to set up a competing network are simply too high to be economically viable. While there are concerns about the sustainability of oil markets for cars, I don’t worry about LPG in rural areas and for industrial uses. I expect LPG to continue in use for decades. That moat is one reason why DCC has such strong business results, year after year. DCC may not be as well-known as Diageo, but both companies have raised their dividend every year for more than a quarter of a century.
I find Buffett’s simple principles for successful stock picking helpful partly because they are so easy to understand and apply. Using this method, I’d buy Diageo and DCC today.