Soaring costs mean UK inflation hit 6.2% in March, the highest level for 30 years. In an environment like this, there’s no substitute for experience. That’s why I’m following Warren Buffett’s methods to help me pick stocks for my portfolio.
Buffett turned 91 last year. He was already a successful investor in the 1970s and 80s when inflation (and interest rates) reached double-digit levels. Here, I’ll explain Buffett’s tips for inflation investing and look at some UK shares I might buy today.
Focus on cash
One of Buffett’s key tips for investing with inflation howling is to focus on businesses that can generate plenty of cash.
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When inflation is high, the cost of everything rises. We’re seeing it in household bills — petrol, gas, electricity, food, and pretty much everything else.
It’s the same for businesses. They’re having to pay more to produce the same amount of output. If a company was struggling to generate spare cash when inflation was low, then it’s going to have even bigger problems now.
If a company can’t generate cash, it will struggle to invest in growth or pay dividends. Ultimately, the value of the business (and its shares) may start to fall.
In the UK, I think some of the best cash-generating shares are in the consumer and financial sectors. These choices reflect some of Buffett’s top holdings too. His company Berkshire Hathaway owns big stakes in US firms such as Bank of America, Coca-Cola Co, and Kraft Heinz.
In the UK, I’m looking at shares such as Unilever, Lloyds, Tesco, and Aviva. I’m also considering tobacco stocks like British American Tobacco, which generates a lot of cash.
Warren Buffett loves pricing power
If costs are rising, then surely companies should just increase their prices to reflect this? It certainly feels like many businesses are putting up their prices at the moment. But the reality is that not all of them have equal pricing power.
Some companies struggle to increase their prices without losing sales. When inflation’s high, Buffett’s advice is to avoid these companies.
As an investor, I want to buy shares in companies that can easily increase their prices. In my experience, this typically means businesses with upmarket brands, or services that are hard to replace.
Once again, I’m taking tips from Buffett’s own portfolio. In addition to the food and drink firms I mentioned above, Apple and Amazon are among Berkshire’s largest equity holdings. So too is games producer Activision Blizzard, whose franchises include Call of Duty.
Some of the UK shares I might buy with strong brands and pricing power include luxury fashion house Burberry and consumer stocks such as Reckitt (Dettol, Durex etc). I might also consider pharma group GlaxoSmithKline, which is about to spin off its large portfolio of branded consumer healthcare products.
What I’m doing
There is no guaranteed way to make money in the stock market. At this stage, no one knows whether high inflation will be short-lived or long-lasting. We don’t know how far interest rates will rise, or whether the UK will suffer a recession.
My hope is that by learning from Buffett and focusing on companies with pricing power and strong cash generation, I can build a share portfolio that will deliver long-term growth.
