The reason a lot of novice investors as well as professionals pore over each year’s Warren Buffett letter is easy to understand. Buffett has a proven investment track record as leader of Berkshire Hathaway and before that, the Buffett Partnership. His advice is based on decades of proven investment success, but is simple to understand and apply.
Here is how I applied Warren Buffett letter advice on investment picks to buy a leading FTSE 100 share.
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The Warren Buffett letter emphasizes some investment characteristics
Buffett is pretty clear and consistent about the sorts of things he looks for when deciding to buy shares in a company.
For example, he looks at how much of a defensible competitive advantage the company enjoys. He calls this its ‘moat’. Just as a moat helps defend a fortified building against attack, a business can have a competitive advantage. This could be due to a proprietary technology, a distribution network, a network effect, or any other reason that helps make it harder for other companies to attack.
The Warren Buffett letter also often includes discussion of the power of brands. Buffett has large holdings in companies built on portfolios of well-known brands, such as Coca-Cola and Kraft Heinz. The reason he likes brands is that they create customer loyalty and can allow for premium pricing. That helps a company by enabling it to sustain high profit margins.
I applied these Warren Buffett letter principles when deciding to buy shares in British American Tobacco (LSE: BATS). The FTSE 100 company has a supply chain and distribution network which helps to form a type of business moat. Additionally, it owns a host of well-known brands, such as Rothmans, Pall Mall, and Camel.
High dividend yield
One of the things I find attractive about BAT is its high dividend yield. It currently stands at 8%, which I see as a good return on my money. But that may reflect the fact that not everyone in the market feels as optimistic as I do about the company’s prospects. Cigarette use is falling in many markets, after all. The brands help provide pricing power, but a shrinking market could translate into reduced profits at some stage.
So far that isn’t happening, though. In fact, in its annual results last week, the company revealed that profits from operations for the year were up 10.5%. Earnings per share rose even more, at 12%.
Reading Warren Buffett letters has also made me understand the importance of always looking not just at earnings, but also at a company’s balance sheet. BAT has net debt of over £39bn. While I expect it to be able to pay down its debt over time if it chooses to, that would damage its ability to sustain dividend payments at the current level. I would be happier if BAT had a lower debt burden.
It’s certainly worth digging into the accounts to get the full picture – as Buffett himself tends to do. A bit of research can be very rewarding.