Billionaire Warren Buffett is regarded as one of the world’s greatest investors. His folksy wisdom has entertained shareholders in his giant conglomerate, Berkshire Hathaway, for decades. Buffett’s advice on a wide range of topics has entered into modern folklore. As a value investor, I’m a huge fan of Buffett. I often look to him for advice on buying cheap shares. Here are two things the Oracle of Omaha has taught me about buying into businesses.
1. Stock up on burgers (and cheap shares) when prices fall
In 1997, Buffett asked, “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?” In other words, if one wants to buy shares, then one should be delighted when prices fall. Instead, many investors do the opposite: they sell at low prices and buy at high prices. Following Buffett’s advice, I’ve sworn off buying pricey US stocks. Instead, I’m trawling the FTSE 100 looking for ‘fallen angels’ (solid businesses with cheap shares).
For example, the share price of drug-maker GlaxoSmithKline (LSE: GSK) has declined for a year and more. On 24 January 2020, the GSK share price spiked to peak at 1,857p. On Friday, it closed at 1,191p, down 666p from this high. That’s a collapse of more than a third (35.9%) in 14 months. It’s also a 52-week low. Today, GSK shares trade on price-to-earnings ratio of 10.6 and an earnings yield of 9.4%. The 80p-a-share dividend equates to a dividend yield of 6.7% a year. But GSK plans to cut this dividend in 2021, as earnings might decline until 2024. Even so, I still see GSK as one of cheapest of cheap shares in the Footsie. Hence, I plan to buy more GSK shares for my family portfolio.
2. Quality is worth paying for
Another favourite Buffett quote is, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. It’s worth paying premium prices to buy into exceptional businesses. But what if you could buy into a brilliant business with cheap shares?
For instance, Unilever (LSE: GSK) is one of the British businesses I most admire. The Anglo-Dutch giant is a global Goliath at selling fast-moving consumer goods. Look in your cupboards and you might find several Unilever brands. That’s because these are among the most trusted and widely bought products in the world. Incredibly, 2.5bn people use Unilever products each day. In 2019, Unilever’s revenues were €52bn (£45bn). Who wouldn’t want a piece of that action? Yet, Unilever stock is creeping into ‘cheap shares’ territory.
At its 52-week high on 14 October last year, the Unilever share price peaked at £49.44. Today, they are on sale at £37.33. That’s a discount of £12.11 a share — almost a quarter (24.5%) — from the 2020 high. To me, this sell-off smells like an opportunity to buy into a world-class business at a reduced price. Today, ULVR trades on a price-to-earnings ratio of 20.2 and an earnings yield of 5.0%. The dividend yield of 4% exceeds that on offer by the wider FTSE 100. In historic terms, these are lowly ratings for this global leader’s shares. But Unilever had bumper sales boost due to Covid-19 restrictions. Alas, this surge is unlikely to be repeated in 2021–22. Difficult economic conditions could also pressure Unilever’s profits. Nevertheless, Unilever’s cheap shares remain high on my buy list for 2021.
