Warren Buffett not only excels as an investor but also stands as a remarkable educator. His frequent public engagements and insightful ‘Letter to Shareholders’ have provided us with a wealth of knowledge regarding his distinctive approach to value investing and emphasis on high-quality investments.
This transparency has enabled us to glean valuable insights from his strategic perspectives and contributes to his reputation as an influential teacher in finance.
The FTSE 100
Unfortunately, Buffett isn’t a big investor in the FTSE 100. He never has been, and currently his Berkshire Hathaway portfolio doesn’t directly own any stocks on the index. If he did invest in UK-listed stocks, we’d certainly see more momentum today.
He holds a particular fondness for investing in the US due to the country’s stable economic environment, well-established legal systems, robust infrastructure, culture of entrepreneurship, and, in recent years, positive investor sentiment.
Although the UK shares some similarities with the US, it tends to exhibit comparatively lower levels of innovation and a smaller presence of retail investors. Furthermore, the nation has endured a prolonged period of negative media coverage.
Nevertheless, it’s important to note that the UK remains a viable investment option, and there exists the potential for overall sentiment to shift favourably in the future.
Buffett’s criteria
So what does Buffett look for in his investments. Here are five top criteria:
- Reasonable Valuation: Buffett seeks stocks that are undervalued compared to their intrinsic value, using metrics like price-to-earnings and price-to-book ratios
- Competitive Advantage: He looks for companies with a durable competitive edge, often referred to as a “moat“. This protects them from competitors
- Competent Management: Buffett highlights the importance of trustworthy and competent management teams. He favours a track record of prudent decision-making.
- Consistent Earnings and Cash Flow: He prefers companies that exhibit consistent and growing earnings over time, accompanied by healthy cash flow
- Long-Term Focus: He prioritises investments in businesses that he believes will maintain their value and growth potential over the long term, rather than seeking short-term gains
Focusing on the FTSE 100
So how can we use these teachings as the FTSE 100 nears a bear market? Firstly, we’re likely to see stock valuations fall relative to their earnings. In turn, this means many stocks will fall within the valuation criteria of certain investors.
For example, blue-chip stock Barclays is now trading at 4.7 times earnings and just 0.42 times book value. This is one of the most incredible undervaluations, with analysts pointing to a 50% upside. The average price target for Barclays is 242.27p.
While there are downside risks associated with every stock — in this case defaults on loans — Barclays has certainly suffered from negative investor sentiment.
We can also look at stocks like Hargreaves Lansdown. The brokerage is down so much it may fall off the FTSE 100 in the coming months. However, it’s trading at a huge discount versus its average P/E. On a forward basis, the P/E looks to be around 11.5 times. Hargreaves Lansdown’s adjusted P/E ratio for fiscal years ending June 2018 to 2022 averaged 29.4 times.
Does it have a competitive advantage? Well, it’s the biggest brokerage in the UK by a long way. Yes, investor activity has fallen in the short term, but it’s got a robust business model, and long-term prospects look positive.
