How hard is it to become one of the world’s most successful investors? It must be hard, as only a few people reach that level of achievement. But Warren Buffett sometimes makes it sound straightforward, with his simple approach to finding shares for his portfolio. I think I can apply the Warren Buffett strategy to finding cheap UK shares for myself.
Taking the long view
One strategy Buffett uses when finding shares to buy is taking the long view. For example, Buffett says that “if you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes”.
That sounds simple – but how many of us do it?
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Buffett’s approach here is not based on how long he plans to hold a share, in my opinion. Instead, he is using the test of a decade holding time as a way of filtering out companies he does not find attractive enough.
There is a difference between a share that might go up soon, for example because its share price has crashed or it is part of an industry seeing quick growth overall, and one that could benefit for years from a company’s business model. What sort of share could Buffett imagine owning for a decade? From his other comments and investment history, we know it is a company he thinks has a sustainable competitive advantage over the long term.
Buffett moats
Warren Buffett sometimes describes such a competitive advantage as a business’s ‘moat’.
I think a lot of UK shares have some sort of moat. For example, a competitor would struggle to build a power distribution network like the one National Grid already has. The recipe for Guinness is unique to Diageo no matter how many other brewers make stout. Some of the polymer technology used by Victrex can only be used by it due to the company’s intellectual property rights.
But a good business does not necessarily make for a rewarding investment. How can I tell whether I should consider such companies as cheap shares to buy now for my portfolio?
Value and the Warren Buffett strategy
Buffett sees value as a combination of an attractive business and share price. So for him, value consists of buying a great business – one he would be willing to hold for at least a decade – at an attractive price.
Taking a long-term mindset can help me assess this value. For example, Diageo currently trades at a price-to-earnings ratio of 27. I do not think that is cheap. But if I am buying the share to hold for a decade or more, the value becomes more attractive to me. I expect the company to keep growing sales of its drinks for years to come. The premium branding helps give the company pricing power. That could help it offset the risks of rising production costs damaging its profit margins. So although the share price is 27 times current earnings, I expect Diageo could earn much more a decade from now.
Taking a long-term buy-and-hold approach to investing is at the heart of the Warren Buffett strategy. It has made him hugely successful as an investor. I am applying it myself now, to find cheap UK shares to buy for my portfolio.
