Warren Buffett is often said to be the most successful investor of all time. And with an estimated fortune of $116bn, earned mainly from his investment vehicle Berkshire Hathaway, I’m not going to argue.
His pithy quotes give clues as to what his core investment principles are — pick quality stocks with good growth potential, and hold them for a long time.
It’s not all about dividends
The American billionaire isn’t fixated on dividends.
Yes, he likes companies that generate cash. But he’s more interested in how this cash is used to grow a business, rather than the amount returned to shareholders.
Take Apple as an example.
This is Berkshire Hathaway’s biggest holding, representing 50% of its equity investments at 30 June 2023. But its stock is currently yielding a miserly 0.5%.
Don’t diversify too much
To my surprise, Buffett’s company doesn’t have a particularly diversified portfolio.
He argues that someone who’s able to understand business economics should be able to find five to 10 fairly valued companies that have long-term competitive advantages.
Buying more than this, and following a more conventional strategy of diversification, is likely to reduce returns and increase risk.
At 30 June, Berkshire Hathaway’s five largest shareholdings accounted for 78% of the $353bn invested.
And this relatively high concentration of investments doesn’t appear to have damaged returns.
Long-term returns
From 1965 to 2022, the company delivered a compounded annual gain of 19.8%, compared to 9.9% for the S&P 500.
Assuming this level of return could be sustained by me for 25 years+, I could turn £10,000 into £914,999.
But I think this is unrealistic.
I don’t have the expertise and experience (he’s 93!) of the American billionaire. Therefore, I’d find it more difficult to identify the types of stock that have delivered these exceptional returns.
However, very little skill is required to invest in an S&P 500 tracker fund. A lump sum of £10,000 — achieving an annual return of 9.9% — could grow to £105,911 within 25 years.
Of course, past returns are not necessarily a good guide to the future.
But for the purposes of this theoretical exercise, I’m going to assume that I’d have approximately £106,000 available after 25 years, to start generating passive income.
Another income
The FTSE 100 is currently yielding 3.9%. If my lump sum of £106,000 was able to achieve this level of return, I could generate an annual income of £4,134.
But there are many stocks in the Footsie that are presently offering better yields. I think it would be possible to achieve a return of 5%-6% by investing in some quality companies — Lloyds, National Grid and BT are three such examples. Of course, in 25 years’ time, there will likely be a different group of high-yield share in which to invest.
But assuming a yield of 5.5%, a sum of £106,000 would earn £5,830 in passive income each year. And there could be some capital growth as well.
OK, this might not give me a billionaire’s lifestyle, but everything is relative.
Growing a lump sum more than nine times, and then using this amount to earn an annual income greater than 50% of the original sum, is impressive by anyone’s standards. I think even Warren Buffett would agree.
