Warren Buffett is a legendary investor. From a standing start he built an investment vehicle that later merged with Berkshire Hathaway. Today the company is valued at over half a trillion dollars.
Here are two lessons from Warren Buffett I try to apply when choosing shares.
Warren Buffett on price
Buffett has a lot to say about valuation. He observed that “price is what you pay. Value is what you get.”
What does this mean? A lot of investors focus on share price. But value can be different to price.
Consider as an example Judges Scientific. Looking at the numbers alone, I wouldn’t necessarily say that the price looks that attractive. The price-to-earnings ratio is around 36. That means that it would take 36 years for a purchaser to repay the price by using earnings, at their current level.
The market cap is £400m, which is around five times the company’s revenue last year.
Hunting for value
But imagine I follow the Warren Buffett approach. I would consider Judges by looking at its value. Judges owns a number of specialist scientific instrument makers. These assets are hard for competitors to replicate.
Customers’ need for precision in scientific instruments means that they will usually be more focused on quality than cost. That gives Judges pricing power.
When assessing Judges on the basis of value, I see a company with a defensible market position that should be able to grow profits for years to come. I think the share price looks high – but I also think that it could represent good value for my portfolio.
That said, there are risks to a company like Judges. Demand could fall, for example, or a change in its experienced management could damage investor sentiment.
Warren Buffett invests rather than trades
One thing a lot of investors struggle to understand about Warren Buffett is his approach to the stock market.
Sometimes he expresses opinions such as not minding if the stock market were to close for years. Why would a famous stock picker say that?
Buffett doesn’t like to move in and out of shares frequently. He’s not a ‘trader’.
Instead, he’s an investor. He finds businesses he thinks have solid long-term prospects. Then he buys a stake in them. Sometimes it’s a big stake, and he purchases the business outright. At other times, the stake is in the form of a shareholding.
By buying shares in businesses he thinks have a strong future outlook, he can become a long-term investor. Indeed, Buffett says that his “favorite holding period is forever.”
Long-term focus
There are some shares I think are attractively priced but I don’t feel comfortable about their long-term prospects. For example, I see potential price upside in Card Factory but I feel less confident about the long-term demand for greetings cards in decades to come.
By contrast, using Warren Buffett investment principles I’d pick a business I think is here to stay. Demand for consumer goods made by Unilever may ebb and flow, but I expect it to be around for decades. Indeed, Buffett tried to buy the whole company a few years ago.
Unilever is the sort of share I would be happy to buy and hold forever. Buffett’s investment insight has made him rich – I’m glad I can benefit from it for free!
