When I’m looking for the best UK shares to buy, I go through a list of several key factors. With thousands of shares to choose from, it’s necessary to narrow my options to a smaller watchlist.
Ticking the boxes
To begin my list I filter for shares that demonstrate quality. I’m just not interested in buying low-quality businesses. One quality-based factor that I look for is a double-digit return on capital employed. And I’m not alone either. This measure of quality is particularly favoured by Terry Smith, manager of Fundsmith Equity.
For the best UK shares, I also want to see strong earnings growth. I consider earnings growth of over 10% to be reasonable. In addition, I like to own profitable businesses. As such, I look for companies that have consistently strong profit margins. A profit margin of over 20% is decent, although the greater the better, in my opinion.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Next, I want to see a robust balance sheet. For instance, I prefer companies with strong cash flow and low debt. Indebted companies with limited cash flow can often lead to financial trouble, and that is something that I seek to avoid.
Finally, I reckon the best UK shares to buy have positive share-price momentum. That is, share prices that trend higher. Often earnings reports can be good catalysts that help provide momentum.
3 of the best UK shares
If I filter for many of these characteristics, the thousands of shares are narrowed down to just a handful. From here I can do more research to find the best UK shares I’d want to buy.
Firstly, my list leads me to consider Games Workshop. This Nottingham-based fantasy miniatures firm is going from strength-to-strength. I particularly like its strong double-digit returns and enviable profit margins. With so much intellectual property and ample opportunities in gaming and movies, I like its potential for growth.
Online trading platform IG Group ticks the boxes too. In July it reported record profits and an encouraging outlook for its business. As well as meeting my criteria, I like that it also offers a 5% dividend yield. In the current climate, that’s a welcome bonus.
My third pick is music and audio specialist Focusrite. This well-run company makes hardware and software for musicians. The music industry was hard-hit in the pandemic, but the need for musicians to set up smaller, multiple operations benefited Focusrite. Trading has been particularly strong this year and I reckon there is further room for its shares to grow.
Next steps
A word of warning, however. Although my checklist to find the best UK shares can often highlight great investments, it’s not guaranteed. I use it as a starting point for further research. In addition, there are various risks to consider (including company-specific issues) that don’t appear in stock filters. It’s important to investigate further to get a balanced view.
Overall, I reckon filtering is a sound method to find good quality shares, with growing earnings, low debt, ample cash flow and share-price momentum.
