Why Warren Buffett’s technique leads me to this FTSE 100 stock

Andrew Woods follows the compounding growth principles of Warren Buffett, one of the most successful investors in the world.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Warren Buffett at a Berkshire Hathaway AGM

Image source: The Motley Fool

Key points

  • Buffett’s principles have led me to BAE Systems
  • A stock with solid earnings and revenue
  • Expanding its US operations

After reading about Warren Buffett’s principles, I took that knowledge and applied it to my own investing. I bought Molten Ventures, a tech-focused venture capital firm, in 2020 and sold it for double the price one year later. I need no convincing that Buffett’s methods work. Now I’ve found a long-term growth stock, BAE Systems (LSE:BA) to buy in the FTSE 100.

Excellent earnings, remarkable revenue

Buffett first inspires me to look at basic company data, like revenue. From the years ending 31 December 2016 to 2020, the growth experienced by BAE Systems has been nothing short of sensational. I don’t mean this in the sense of a 10 times share price increase, or annual compounding growth of 50%. No, BAE Systems is sensational because it produces solid results year in, year out.

This stock has managed to increase its revenue by 5% for the calendar year 2020. I am impressed with this figure because it shows steady growth during the first year of the pandemic. For context, another stock engaged in defence contracts, Babcock, suffered a slight fall in revenue.

As a defence and aerospace business, the company has five distinct segments. These are mainly centred in the US and UK, but there are other operations in Europe, Scandinavia, and the Middle East.

What’s more, BAE Systems boasts exceptional earnings-per-share (EPS) growth. Warren Buffett is particularly keen on this data, because it shows how well or otherwise the stock is earning for its shareholders. This figure has increased to 46.8 in 2020 from 40.3 in 2016. Buffett would use these numbers to calculate compounding annual growth rates. In this case, BAE Systems EPS compounding growth is 3%. While this may not seem exciting, it tells me that this is a stock that delivers solid results year in, year out. On Buffett’s principles, this would be an excellent choice for my portfolio.

Dividends vs. retained earnings

Over the last five calendar years, BAE Systems has been consistent with its dividend cover. This usually stands at about 1.9p per share, except a bumper year in 2019. The yield has naturally moved around from 1.7% to 7.7% depending on share price.  

This stock uses whatever profits it retains to expand. Warren Buffett has consistently mentioned retained earnings over the years and it is something I try to factor into my investment decisions.  In November 2021, for instance, it bought Bohemia Interactive Simulations. This is a military simulation training and software company whose largest customer is the US military. JP Morgan has recently downgraded BAE Systems, however, because it is exposed to the US market. JP Morgan has recently said that this market is “now in a slowdown”. For me, though, the purchase of Bohemia will not only increase the company’s presence in the US, but it shows me that the management is constantly focused on putting earnings to work.

Buffett’s principles have guided me to success before. If I find a company with solid compounding growth and increasing revenue, then I will add it to my own portfolio. BAE Systems is no exception and I will by buying straightaway.   

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Andrew Woods has no position in any of the shares mentioned. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. The Motley Fool UK has no position in any of the shares mentioned. 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.

More on Investing Articles

Modern suburban family houses with car on driveway
Investing Articles

Should I snap up Taylor Wimpey shares at £1.30?

With the Taylor Wimpey share price down by almost 30% this year, should I snap up some shares while it's…

Read more »

Young female analyst working at her desk in the office
Investing Articles

How I’m finding shares to buy now – and keep for a decade

Our writer has been looking for shares to buy using an approach that looks both at long-term profit prospects and…

Read more »

Bearded man writing on notepad in front of computer
Investing Articles

What’s happening to the Petrofac (PFC) share price?

The Petrofac (LON:PFC) share price has had a seriously erratic year so far. I take a look at the latest…

Read more »

Young black woman in a wheelchair working online from home
Investing Articles

The Aviva share price is flying! Should I buy this 7% yield?

Despite recent gains, Roland Head thinks the Aviva share price could still be too cheap.

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

Here’s 1 passive income opportunity not to be missed!

This Fool details a passive income opportunity that could bolster his holdings, and the shares trading at cheap levels too.

Read more »

Young brown woman delighted with what she sees on her screen
Investing Articles

The Legal & General share price is dirt-cheap with a juicy dividend yield!

Jabran Khan takes a closer look at the Legal & General share price which looks like an opportunity to boost…

Read more »

Playful senior couple in aprons dancing and smiling while preparing healthy dinner at home
Investing Articles

If I’d invested £1,000 in this top lithium stock 5 years ago, here’s how much I’d have now!

This lithium stock has gone from strength to strength over the past year. But has it flown too high, or…

Read more »

Smiling white woman holding iPhone with Airpods in ear
Investing Articles

A growth stock with a price-to-earnings ratio of just 9.7! Should I buy Yalla?

I'm generally not too keen on investing in dollar-demonated stocks at the moment. But Yalla, with its low price-to-earnings ratio,…

Read more »