Warren Buffett is among the most famous investors in the world. The so-called ‘Oracle of Omaha’ favours value investing, a strategy that has seen him build a vast net worth.
However, many people might be unaware that Buffett built the majority of his wealth in his later years. In fact, he built 99% of his wealth after the age of 50.
With some fairly sizeable purchases coming up, it is entirely possible that I could enter my 30s with almost no savings to my name. So how can I build up my wealth following a house purchase? Well, I’m looking to Buffett for inspiration.
Value investing
Value investing is about finding stocks that are meaningfully undervalued and investing in them. Buffett often looks for the company’s valuation to reflect a 30% discount versus what he considers to be the intrinsic value.
Understanding a company’s intrinsic value requires research. I can obviously look at near-term valuations such as the price-to-earnings ratio and the EV-to-EBITDA, and compare them against industry peers.
But, as I invest for the long term like Buffett does, I need to look further into the future.
The discounted cash flow model is one way of doing this. Essentially, I’m estimating what a company will earn during the period of your investment and then discounting it, because £1 today is worth more to you now than £1 in five years.
This method of valuation can be a mathematically challenging process but, thankfully for me, there are plenty of online calculators to do the hard work for me.
The discount cash flow calculation is certainly a good start. But it can be hard to predict how much a company will earn in the future if I don’t truly understand the industry or the company itself. That’s why Buffett sticks to what he knows best, including stocks like Apple.
Investing for the long run
Buffett invests as if he is going to hold shares forever and doesn’t take short positions. This doesn’t mean he doesn’t sell. But he’s investing for the long run.
And there is good reason for this, especially if I’m confident in the long-term prospects of the firms I’m investing in.
The FTSE 100 is testament to the general upward trend in share prices. The index today is worth four times what is was 30 years ago.
Compound returns
Ok, so the above all sounds great. But what should I actually do? Well, the compound returns strategy is the one for me. This involves investing in stocks paying dividends — the majority of value stocks do, although these aren’t guaranteed. And then reinvesting my dividends year on year.
But as I’m starting with nothing, I need to commit to invest regularly. For example, if I were to invest £500 a month into stocks with an average 5% dividend yield, and reinvest these dividends over 25 years, at the end of the period, I’d have £300,000.
But this calculation doesn’t take into account share price gains. As a rough calculation, based on historical gains, I could expect this £300,000 to be worth £600,000.
The compound returns strategy is by no means a guaranteed winner but, for me, it certainly seems less risky than investing in growth stocks.
