Investing in UK shares can be a great way of building wealth over time. The FTSE 100 has returned an average of 7.38% per year over the last decade.
That’s a good result. But I’m aiming to do even better by following Charlie Munger’s advice.
Charlie Munger
Warren Buffett’s collaborator is a great source of investing wisdom. And one of my favourite insights is the following:
It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.
Charlie Munger
Munger’s point here is that achieving great returns involves focusing on only really great investment opportunities. For above average returns, I need to buy shares in companies that are better than the average.
But what makes a quality company? I’m looking for two things – a business that has a good competitive position and the ability to generate a lot of cash.
Quality businesses
By these standards, I think that Experian (LSE:EXPN) stands out as one of the highest-quality UK shares. It generates a return on its fixed assets of around 386%.
For context, Diageo generates an 81% return, Microsoft manages 86%, and Starbucks achieves 28%. These are all terrific companies, but Experian really stands out.
| Operating Income (bn) | Net PPE (bn) | Return | |
|---|---|---|---|
| Diageo | £4.83 | £5.97 | 81% |
| Experian | $1.43 | $0.37 | 386% |
| Microsoft | $82.82 | $96.38 | 86% |
| Starbucks | $4.43 | $15.58 | 28% |
In terms of cash conversion, Experian converts 90% of its operating income into free cash flow. That’s also a very impressive result.
Microsoft manages to convert 72% of its operating income, Starbucks converts 57%, and Diageo manages 43%. Once again, Experian sets itself apart.
| Operating Income (bn) | Free Cash Flow (bn) | Conversion | |
|---|---|---|---|
| Diageo | £4.83 | £2.09 | 43% |
| Experian | $1.43 | $1.28 | 90% |
| Microsoft | $82.82 | $59.62 | 72% |
| Starbucks | $4.43 | $2.56 | 57% |
Valuation
Identifying quality businesses is crucial. But if I buy them at the wrong prices, I won’t be able to generate the kind of returns I’m looking for.
In 2014, Experian shares were trading at a price-to-earnings (P/E) ratio of 14. Since then, the stock has gone on to return an average of 12.7% per year.
A year earlier, the stock trading at a P/E ratio of 22. If I’d bought Experian shares back then, I’d have managed an annual return of just 8%.
This illustrates Munger’s point. If I take mediocre opportunities, then I’ll get mediocre returns.
Patience
Following Charlie Munger’s approach involves only taking outstanding opportunities. But with Experian shares trading at a price I consider high at the moment, what should I do?
Waiting for lower prices is risky – the stocks I’m watching might never reach the prices that I’m hoping for. Equally, buying weaker business or paying higher prices is likely to lead to lower returns.
I think that a better plan is to keep learning about different stocks. The more quality businesses I have on my radar, the better my chances of finding one at a good price.
My investing plan involves focusing on the best opportunities I can find. I might only own a few UK shares, but I think this gives me the best chance to build significant wealth over time.
