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I’d consider buying this share using Warren Buffett principles

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close-up photo of investor Warren Buffett
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Investor Warren Buffett dispenses a lot of wisdom for free. From his legendary annual letters to his appearances in the media, the Sage of Omaha frequently provides insight into how he invests.

Applying some of those principles, here’s why I would consider buying a well-known UK share for my portfolio.  

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Pricing power

Buffett is a big fan of brands. That is evident from his investments in companies such as Coca-Cola and Kraft Heinz. The reason Buffett likes brands is because they move a product away from being a commodity. They give the owner pricing power. That can be helpful to boosting profit margins and sustaining them for years or even decades.

One UK company that owns a wide range of brands is the drinks manufacturer Diageo (LSE: DGE). Its stable includes iconic brands such as Johnnie Walker and Guinness as well as newer ones like Seedlip and gin line Aviation.

These brands give Diageo pricing power. The basic ingredients of many drinks are cheap, but by packaging them and branding them, the company is able to achieve premium prices. That helps explain why the company is able to achieve high profit margins. Last year, Diageo’s post-tax profit was 8.2% despite the pandemic. The prior year, it was 17.3%.

Warren Buffett on simplicity

There’s another common trait to Warren Buffett’s investments. He often likes to invest in companies that have relatively simple, proven business models, such as retailers, train companies, and drinks makers.

Why does Warren Buffett seem to like simple business models so much? It’s partly because it makes it easier for a shareholder to monitor how a company is performing. No specialist expertise is required. It also forces transparency – such a company can’t hide behind excuses about an evolving market or needing to educate customers. It’s no coincidence that Diageo has top class management. It has spent decades and benefited from a global footprint getting to know exactly what works when it comes to selling branded drinks.

Recurring revenues

Another feature of many of Warren Buffett’s investments is that they benefit from frequent repeat custom. Customers keep coming back for more. That helps profitability, as it means a company does not need to spend as much money finding new customers for its products.

Branding can help with that. Unique products can also help – Guinness is a good example of that. There are other stouts and porters, but no drink offers exactly the same flavour and texture as Guinness. That helps drive customer loyalty. In many pubs, I notice that Guinness is among the more expensive beers on offer. Diageo is able to sustain such pricing because its product is unique.

Risks

I think Diageo offers a lot of the attributes Warren Buffett looks for when investing and I’m considering buying its shares.

However, there are some risks. It is heavily exposed to the alcohol market, but many more health conscious consumers are cutting down on alcohol intake. That could hurt revenues and profits. There is also uncertainty about the future of nightlife venues, many of which have been financially decimated by lockdowns. That could hurt revenues in future.

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Christopher Ruane has no position in any shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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