Famed investor Warren Buffet has put his investment knowledge to good use, earning billions of pounds in the process.
Here is how I would put some of that same knowledge to use, myself, when investing £20,000.
Investing for the long term
Will people drink more Coke this year? Will they drink less? Could sales surge in a hot summer? Might commodity price increases hurt the company’s profit margins?
Warren Buffett has been a big shareholder in Coca-Cola over many decades. Yet I expect he spends little or no time thinking about questions like the ones above. That is because the investing legend is not investing in a company based on what he thinks might happen there next week – or even next year.
Instead, he is buying companies he thinks have enduring competitive advantages that he reckons could help them make profits for years or decades to come. That does not mean it will be smooth sailing – falling sales or rising costs are a risk for Coca-Cola, as for all companies. But Buffett ignores short-term bumps and looks at the long-term strategic outlook.
If anything, a short-term problem can sometimes push shares of a promising company down to a more attractive level. For example, in 1962 a small subsidiary of American Express was engulfed in a scandal. The share price fell but Buffett reckoned the long-term prospects for the financial services company had hardly changed. It continued to benefit from a strong brand and established customer base. The Sage of Omaha bought American Express shares while the scandal kept the price low. Today, his company, Berkshire Hathaway, owns 19.9% of American Express. It paid $1.3bn for a stake now valued at $24.8bn.
I am using a similar logic in considering Victrex as a possible addition to my ISA. The company is a specialist polymer manufacturer, so could see profits hurt by both raw ingredient and energy cost inflation. That risk has been weighing on the Victrex share price lately. But in the long term, I expect energy prices to fall again at some point. Meanwhile, the Victrex business should still have the same attractive points it does today, like proprietary products that give it a sustainable competitive advantage. I also like the fact that some applications for its products are mission-critical, making it more likely that customers will accept price rises.
Keeping things simple
When Buffett invested in some old, well-established Japanese trading houses, many investors saw it as an unusually exotic move for him. That is because he tends to stick to companies based in his home market. Not only that, he only invests in business areas where he feels he has a good grasp on the industry fundamentals.
I am following the same approach when it comes to my ISA. I understand the market in which Unilever operates and its business model. That does not mean it is necessarily a good investment for me – but it does at least enable me to assess the company’s prospects. By contrast, the business of space exploration lies beyond my horizons both literally and metaphorically. So I will not be buying a share such as Virgin Galactic for my ISA. I simply have no way of understanding its business prospects with the same level of confidence I would have when considering Unilever. I am a down to earth investor.
A lot of investors seem to think that it is hard to make good returns when keeping things very simple. I reckon the opposite is often true – it is difficult to make good returns by making things complicated.
Looking at what drives value
A lot of investors buy shares based on their price, without understanding the business. Warren Buffett sees shares as a small slice of a business. He only owns shares in businesses he thinks have excellent future prospects.
He does that by looking at what assets a company has that could help it create value in future while keeping competitors at bay. For example, it may have an iconic brand like Coca-Cola, an entrenched customer base the way Apple does, or a unique distribution network as seen at some of the energy companies Buffett owns.
At a job interview, you might have to explain to the interviewer what skills or abilities you have that make you uniquely well-suited to getting the job done. The Oracle of Omaha basically uses that approach to choosing businesses in which to invest.
I am doing the same for my ISA. Whether it is owning premium brands like British American Tobacco or having an entrenched customer base as at Lloyds, I am trying to identify businesses that have something to help them create value in coming years.
Warren Buffett on diversification
£20,000 is a lot less than Buffett has at his disposal to invest.
If anything, though, I think that makes it even more important that I follow his lead and make sure to keep my portfolio diversified. Buffett has made some phenomenal investment choices. But he is the first to admit that he has also made some big mistakes. Some of those came despite his own best efforts, as for example when an accounting scandal engulfed Tesco some years ago. There was no way the famed investor could have expected that.
Diversification helps reduce the impact on the Berkshire Hathaway portfolio if one of its investments turns out less well than hoped, for any reason. With £20,000 compared to Buffett’s billions, it is hard for me to spread my investment across as many companies as he does. But I still have enough money to make sure my portfolio is diversified – and I plan to do exactly that.
Focussing on sleep
Warren Buffett says that no investment is worth losing even one’s night sleep over.
But the sad reality is that many people lose sleep over investments on a far more modest scale than Buffett’s holdings. I think his advice on this point is powerful and practical. Rather than worrying about distressed companies in turnaround situations or the business prospects for an unproven new product, I prefer to invest in shares that will not cause me to lose sleep. After all, investing should be a way to improve my quality of life – not reduce it.
