Billionaire Warren Buffett has had the sort of success as an investor that most of us could only dream of.
But his journey as an investor has involved several simple stages. The first one is familiar to many of us as it is a common place to start. But it was the second stage, sidelining that initial approach in favour of a different one, that Warren Buffett reckons transformed his performance as an investor.
Value-based investing
Buffett started as what is commonly known as a ‘value investor’. In other words, he tried to find shares that were selling for less than their current worth.
That is a very common method for new investors and a lot of people use it.
For example, why do I own penny share Logistics Development Group? The main reason is the apparent value on offer. The most recent unaudited net asset value per share, released last month, was 26.1p. The current share price is over 40% less than that.
I am hopeful the company’s investments, such as in Finsbury Food Group, could grow in value over time. But even just based on the current valuation, Logistics Development Group shares look like good value to me.
Buffett’s lightbulb moment
But value investing can be compared to a cigar butt.
How? Warren Buffett puts it like this: “I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.”
Given that this approach was making him money, what caused Buffett to move from that stage of his investing career to another one?
He credited his partner Charlie Munger with the lesson, as Munger was willing to pay more for a branded sweet maker (See’s Candies) than Buffett had been initially.
Munger reckoned that, if a business was promising enough over the long term, paying a bit more for it would end up being neither here nor there in the grand scheme of things. So it proved with See’s.
As Buffett reflected, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.
How I’m using this approach to invest
Warren Buffett’s approach has influenced me.
For example, when I recently invested in Ashtead (LSE: AHT), the price struck me as fair for what I see as a wonderful company – but not exactly a screaming bargain.
Currently, its price-to-earnings ratio is 17. That could move even higher if earnings fall, for example because a weak US economy leads to less demand in the US for the construction equipment Ashtead hires.
But I see it as a wonderful business. It has a proven business model and has gained considerable size over time. That makes it an attractive first choice for its large customer base and also allows it to service clients across many different construction sites at once.
Ashtead has taken the sort of long-term approach Warren Buffett himself likes, implementing a series of strategic plans to help push its performance to the next level. That remains work in progress, something I hope could help lift the Ashtead share price higher over time.
