The UK’s FTSE 100 index is home to some brilliant shares. From defence companies to consumer goods champions, there are a lot of stocks that have made investors money over the years.
But what are the best Footsie shares to consider buying for a portfolio for the next five years? Let’s discuss.
Warren Buffett’s playbook
When I’m investing for the long term, I follow Warren Buffett’s advice and look for companies that are highly likely to see strong earnings growth in the years ahead. To quote the stock market legend: “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now.“
Now, I’ve found that the easiest way to find growth companies is to look for businesses in growth industries. So, what I do is take a thematic approach and focus on big, powerful themes that will lead to growth for certain businesses.
Like Buffett though, I’m not just seeking growth – I’m also looking for quality. I want to invest in companies that are leaders in their fields with strong competitive advantages, robust balance sheets, and high returns on capital.
History shows that these kinds of companies tend to be good long-term investments. Here’s another great quote from the investment guru: “If you are in a wonderful business for a long time, even if you pay a little bit too much going in you will get a wonderful result if you stay in a long time.”
Of course, valuation is important as well. I don’t want to massively overpay for a business because that could lead to lousy returns.
That said, like Buffett, I’d rather pay a bit more for a high-quality company that’s likely to have success over the long run, than go for a lower-quality value stock. Over the long run, the quality of the company is likely to have a bigger impact on returns than the starting valuation.
Putting this all together and applying it to the FTSE 100, some names I like are:
- BAE Systems (the defence spending theme)
- AstraZeneca (the healthcare theme)
- Smith & Nephew (the ageing population theme)
- Prudential (the rise in emerging market wealth theme)
- Sage (the digital transformation theme)
All five of these stocks have plenty of long-term growth potential and decent levels of quality, in my view. And they all trade at reasonable valuations today.
So, I reckon they’re worth considering for the long term.
What about Rolls-Royce?
Now, I’m sure some readers are wondering why Rolls-Royce (LSE: RR.) didn’t make the list. It’s one of the most popular Footsie shares today.
Well, for me, it’s a valuation issue. Currently, the price-to-earnings (P/E) ratio is about 40.
To my mind, that valuation is a little stretched. I’d say a reasonable valuation is 25 times earnings.
I do think Rolls-Royce has plenty of growth potential over the next five years. With exposure to the defence and nuclear energy markets, it has multiple long-term growth drivers.
As for its quality, it has really improved under CEO Tufin Erginblic. For example, return on capital last year was near 30%.
I just don’t see it as a strong buy to consider today. In my view, the valuation doesn’t leave any room at all for operational setbacks.
