Warren Buffett has an impressive record of investment returns over the course of many decades. He has enjoyed boom times in the stock markets — but he has also owned shares during some vicious economic downturns.
Here is how I think his approach can help me invest in a recession.
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Going for quality
When the stock market overall does well, many less impressive shares are boosted as result. It is a case of a rising tide lifting all boats. So even companies with poorly performing businesses may see their share price do well.
But when the economy gets worse, investors often focus more on the quality of companies in which they invest. That can mean that weak companies become more obvious in a recession than during boom times. As Buffett says: “Only when the tide goes out do you discover who’s been swimming naked”.
Business sectors with long-term prospects
So how does he spot the companies that could do well even in a recession?
One of the key things he does is looking at what customer demand for a likely type of product will be in future. Some products are expensive or not urgently needed, so in a recession customers may put off buying them. Actually, I think that is part of the reason for the falling share prices of AO World and Victorian Plumbing, which have fallen 70% and 82% respectively over the past year. Investors reckon that for many customers, a new kitchen or bathroom is a luxury not a necessity and might be put off if money is tight.
By contrast, some of the areas in which Warren Buffett invests – such as freight railways and foodservice distributors – seem likely to see fairly robust demand during a recession. Even Coca-Cola, though its products are far from a necessity, could be an affordable treat for many people when money is tight.
So he is investing in areas that could hopefully do well when the economy is weak as well as when things are going well.
Investing like Warren Buffett
I think this is an approach I can use in my own investment.
When thinking about what companies I could buy, I consider what the long-term prospects of a business sector are like. Will customer demand likely be resilient in future?
I then look at any competitive advantage a specific company may have over other firms in that sector. For example, like Buffett’s freight railways, firms such as National Grid and BT own networks that it would be costly for a competitor to try to build from scratch. Like Coca-Cola, companies such as Diageo and AG Barr own unique brands like Guinness and Irn-Bru.
That is why I am looking for shares in companies that I think can do well even in a recession. I think using the Warren Buffett approach can help me refine my search as I build my portfolio.