Warren Buffett loves a bargain. As the Berkshire Hathaway CEO once put it: “Whether we’re talking about socks or stocks, I like buying quality merchandise when it’s marked down.”
I’m not in the market for socks right now (saving that for Christmas). But I’m always interested in quality shares that are selling cheaply and Black Friday seems like a good time to be looking.
Finding stocks to buy
From an investment perspective, working out when a company’s shares are cheap is straightforward but not always easy. It involves comparing the price of the stock today with the cash the business will make in future.
The trouble is, a company’s future earnings aren’t guaranteed. Investors can make estimates, but there is always a degree of uncertainty with this part of the equation.
Fortunately, Buffett has two principles to help with this. The first involves sticking to businesses the Oracle of Omaha can understand well – those that are within what he calls his ‘circle of competence’.
Even so, there’s still scope for things to go wrong. So Buffett insists on a margin of safety and only invests when a good investment return doesn’t depend on everything going to plan.
Competence
So what does this look like in practice? Take AstraZeneca as an example – the stock is down 8% since the start of the year and the company’s share price reached a 52-week low recently.
This doesn’t automatically mean the stock is a bargain, though. That comes down to how much cash the company is going to make in future and this isn’t necessarily easy to judge.
As a pharmaceuticals company, AstraZeneca’s profits depend on its ability to develop and market drugs successfully. The average cost of bringing a drug to market is around £1bn and the success rate is roughly 9%.
Without specialist technical knowledge, it’s hard to assess the company’s drug pipeline accurately. As a result, it’s very difficult for someone like me to identify AstraZeneca as a stock to buy.
Good deals?
I do think there are some good opportunities at the moment, though. Two that stand out to me are Diageo and Unilever – consumer goods companies whose future prospects don’t rely on complicated technical innovation.
Shares in Diageo are down 22% this year as growth in Latin America has stalled. But at a price-to-earnings (P/E) ratio of 17 and anticipated growth prospects of between 5% and 7%, I think the stock looks like good value.
The Unilever share price has fallen by around 9% since the start of January as continued inflation has started to weigh on the company’s sales volumes. But a dividend yield of close to 4% looks like a good opportunity to me.
Both companies rely on their strong brands for a competitive advantage. And their size helps them maintain this edge by allowing them to spend more on marketing than their rivals.
Risks and rewards
Going forward, the main risk I see for Diageo and Unilever is the continued threat of inflation. Higher prices can cut into margins and weigh on sales volumes.
At today’s prices, though, I think both are Black Friday buying opportunities for my portfolio. They are businesses that are relatively easy to understand and trade at what look like good prices today.
