Different billionaires have their own paths to fortune. But a common thread is that many of them build wealth by buying stakes in businesses for much less than they turned out to be worth. Buying cheap shares has been a key contributor to the fortunes of people like Warren Buffett.
Excitingly, the stock market allows me to buy the same shares at the same prices as is offered to billionaire investors, even though my means are nothing like theirs.
If I had a spare £500 to invest today and wanted to start buying cheap shares as I tried to build wealth, here are the steps I would take.
Differentiating cheapness from value
The old saying suggests that some people know the price of everything and the value of nothing.
In other words, price and value are different. Just because a share has a low price does not mean it is good value. Conversely, even a share with a high price can offer great value.
As Buffett says, price is what you pay and value is what you get.
How to find brilliant shares to buy
So if not just share price, what would I be looking for?
Basically it comes down to a combination of price and long-term financial outlook.
If a company does not look like it has an excellent financial future then I would see little point to invest in it. An example of a company that I think meets that criterion is Apple, which is Buffett’s biggest shareholding.
It benefits from a large and likely growing market, strong brand, unique product technology and outstanding pricing power. That all adds up to a great business.
Yet I would not invest in Apple right now. Why? Its share price is not cheap enough to offer me the kind of value I want relative to long-term prospects.
Shares on sale
So what is an example of the sort of cheap shares I am discussing?
I think one of the shares in my portfolio illustrates the point, namely British American Tobacco.
At a price of over £23 per share, it may not seem cheap. But that is barely six times earnings. Yes, the company risks seeing revenues and profits fall as cigarette smoking declines. But it is a cash generation powerhouse with strong brands, that is quickly growing its non-cigarette business.
Right now, in fact, I think there are quite a few such cheap shares on sale without even having to look beyond the FTSE 100.
Starting with £500
How could I take advantage of this with only £500 to spare? I would begin by setting up a share-dealing account or Stocks and Shares ISA.
Then I would make a list of cheap shares that meet the criteria I laid out above. Diversification is a simple but important risk management strategy so I would spread the £500 over two or three different shares.
Then, as a long-term investor, I would hold the shares for years to come, unless something happened to change the investment case.
First, though, I need to find them!
