Warren Buffett has a style of investing that is simple, but not easy to follow. It involves buying shares in great companies when they trade at attractive prices.
That means accurately identifying when a business is a great one and correctly determining what the price of its shares should be. And there’s one thing that’s fundamental to both of these.
Circle of competence
When it comes to following Warren Buffett’s approach to investing, the most important thing is sticking to companies I can understand. Without that, finding shares to buy just becomes a matter of luck.
Working out whether a company is a good one involves more than just reading its financial account. It involves understanding the value of its intangible assets.
A great example is Coca-Cola. A real strength of the company is its franchising agreements with its bottling companies, but this isn’t obvious from its balance sheet or its income statement.
A good understanding of a business is also crucial to valuing its shares accurately. Without a clear view of the competiton, it’s impossible to tell if risks are being appropriately priced in or not.
Buffett calls the range of businesses he can understand his ‘circle of competence’ and maintains that staying within this is crucial to investing well. I agree, which leads me to UK stocks.
UK shares
As an investor, I’m looking for cases where a share price is understating the strength of the business or overstating the risks. That means I need to know something the market doesn’t.
Being based in the UK, I think there’s a better chance of this with stocks from the FTSE 100 and the FTSE 250. A lot of these are companies that I experience first-hand.
Two good examples are Greggs and J.D. Wetherspoon. These are businesses that I buy things from myself and this puts me in a decent position to understand those businesses.
It’s not that I have an extensive knowledge of their product ranges (though I do). It’s that I know what they represent to their customers in terms of consistency, convenience, and value.
With these kind of stocks, I have a natural advantage when it comes to seeing opportunities. They don’t require deep technical knowledge and I’m well-placed to understand their distinct advantages.
Investing in 2024
I’m not saying I’ll only buy UK shares in 2024. I think there are other businesses that I can evaluate well enough to invest in with a big enough margin of safety.
Nor am I saying that I have a unique advantage when it comes to assessing every UK stock. There are some that are just too complicated for me to give an accurate estimate of what they’re worth.
My plan is to stick closely within my circle of competence. And that involves being aware of where I have a natural advantage when it comes to assessing.
As I see it, this is entirely in line with how Warren Buffett thinks about investing. The Berkshire Hathaway CEO mostly invests in US stocks for similar reasons to the ones I’ve outlined here.
