Different investors have their own ideas on how to spot great investment opportunities. Some follow a value approach, looking for shares that trade for less than what they seem to be worth. Others favour a growth strategy, hoping to get in early on the big winners of the future. I use both approaches when choosing UK shares for my portfolio. But ultimately, I think all my investment choices come down to a version of value investing. After all, I am trying to buy great companies at substantially less than I think they are worth.
Warren Buffett on value investing
That is basically the approach taken by famed investor Warren Buffett too.
He does not buy mediocre companies just because they trade below their worth. Indeed, Buffett says: “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
But the Sage of Omaha does like to buy shares he thinks look very cheap compared to their long-term value. I am taking the same approach to find cheap UK shares I can add to my portfolio.
Price and value
Cheapness is an expression of relative value. So I cannot judge whether shares are cheap just by looking at their price. While price is a critical factor, I also need to consider what I think a company’s true value is.
That can be hard to do as often trying to judge how a company might perform in future is difficult. Take my investment in pubs operator J D Wetherspoon as an example. In the long term I expect pubs to remain popular, although I think declining beer consumption among younger people is a potential risk to profits.
But what about rising costs, from electricity to staff? Could they eat into Spoons’ profitability badly? Might a recession dent enthusiasm for drinking out of home?
Clearly, valuing a company is a challenging task. I do not think that is surprising: if it was easy, more companies would be fairly valued. But I see that as an opportunity for me as an investor. It is partly because so many people find it hard to value companies that I can sometimes buy shares for much less than I think they are worth.
Hunting for shares to buy
That is the approach I am taking at the moment.
For example, in late November I bought Superdry because I felt the retailer’s brand and profitable business were worth far more than its market capitalisation suggested. Since then they have risen over 50% — in less than two months.
I do not think bargains exist only in a weak market. No matter what is happening in the wider stock market, there are often businesses that are misunderstood by investors or whose prospects are stronger than many people think.
So I am always looking for what I think seem like great businesses, then trying to value them. If I can buy their shares much more cheaply than I think they are worth, I will consider adding them to my portfolio.
