Famous investor Warren Buffett has not become incredibly wealthy by overpaying for shares. But at the same time, he stopped buying shares only because they were low-priced early in his career. Buffett’s approach is to buy quality companies, but without overpaying for them. Here is how I am applying Buffett investment principles in hunting for cheap UK shares to add to my portfolio.
Price and value
Buffett famously said that “price is what you pay, value is what you get”. In other words, just because something sells at a low price, it does not mean that it is a bargain. Instead, it is important to hunt for high-quality companies selling at attractive prices.
For example, I am not buying Cineworld for my portfolio even though its shares sell for pennies. With its huge debt pile and an uncertain outlook for customer appetite to visit cinemas, I see considerable risks in the share. Arguably the risks are priced in, and if Cineworld manages to survive in its current form, shareholders could see handsome rewards. But that feels more like speculation than Buffett-style investing to me.
Applying the Warren Buffett method
By contrast, using the Buffett method I would consider adding Carr’s Group to my portfolio. The agricultural feed and fuel supplier has a competitive advantage – what Buffett calls a “moat” due to its long presence and customer relationships in a confined geographical area.
Trading on a price-to-earnings ratio of 19, I would not say the share price is low. But I regard it as cheap for the quality of the business and its long-term outlook. There are always risks in a business, and changes to agricultural funding could shift buying patterns and hurt profitability at Carr’s. But decades from now, farmers will be buying animal feed and fuel. I think that sets Carr’s up for continued success.
Watch the crowd
Some of Buffett’s moves are mainstream, like buying shares in Apple. But he is sometimes a contrarian investor. He might look at what people are doing and ask if it creates an opportunity for him to do the opposite.
So, for example, he talks about being greedy when others are fearful. That approach sits within his overall investment framework though and he still look for quality. Clearly many investors are fearful about Cineworld right now, but that alone does not make it an attractive investment to me (or Buffett). By contrast, I see an opportunity for my portfolio in Boohoo. Its shares have crashed 75% in the past year. Like Cineworld, they trade as penny shares. So clearly, many investors are fearful. That is why, as Buffett puts it, I have become greedy. I bought Boohoo shares for my portfolio and then extended my holding.
There are definitely risks here – supply chain inflation and logistics costs are expected to lead to reduced profitability at the company. But with the sort of long-term perspective Warren Buffett takes, I hope these are just temporary problems. Boohoo’s brands and customer base give it a competitive advantage. Unlike Cineworld, it remains profitable. Warren Buffett values profitability and competitive advantage. And I agree!
