Warren Buffett is among the most famous investors worldwide. He’s amassed a net worth in excess of $100bn as of November 2022 — as a result, he’s the world’s sixth wealthiest person.
Naturally, we all want to replicate what the so-called ‘Oracle of Omaha’ has achieved. Buffett uses a value investing strategy and value investing strategies have consistently outperformed the index over the last century.
So how can I invest more like Buffett, and what does this mean for my stock picking?
Value investing
Value investing involves selecting stocks that trade for less than their intrinsic or book value. This provides us with a security’s margin of safety. Buffett is known to look for a margin of safety around 30%, or even higher.
Calculating this margin of safety requires investors to undertake some fundamental analysis. This analysis revolves around metrics such as the discounted cash flow (DCF) model and near-term valuations such as the EV-to-EBITDA.
This value investing approach often requires a contrarian mindset, meaning not following the crowd, and having a long-term investment horizon.
Discounted FTSE stocks
The FTSE 100 might be pushing upwards, but many stocks trade at a discount in the UK. That’s because the indices have been hauled upwards by surging resource stocks. The FTSE 250 is more illustrative of the challenges UK firms have faced — it’s down 8% over the year.
So amid this bear market, I feel now’s a good time to find undervalued UK stocks that could meet Buffett’s criteria.
But he also tells us to focus on quality as well as the discount, saying he’d rather pay a fair price for a great company than a great price for a fair company.
Top picks
Barclays is an unloved UK bank. Many UK financial institutions haven’t been popular with investors for some time. And this is why I see it as an interesting area of the market. A DCF model with a 10-year exit suggests that Barclays could be undervalued by as much as 68%.
Analysts expect Barclays could also benefit to the tune of £5bn in the coming two years from rising interest rates.
Right now, it’s the cheapest UK financial institution, trading with a price-to-earnings ratio of 4.8. That will reflect some of the challenges of the past 12 months — fines and impairment charges — but it’s a good starting point for my investment.
Another pick is medical equipment specialist Smith & Nephew. This stock has suffered since the start of the pandemic as national resources were redirected towards Covid and away from hip replacements.
A DCF model with a 10-year exit suggests the firm could be undervalued by as much as 40%. 2023 should be a better year for the firm, as Covid becomes less problematic in the healthcare sector and the backlog of elective surgeries is tackled. However, inflation will remain a challenge, putting pressure on margins.
In the long run, I’m particularly bullish. We have an ageing population and this will provide increasing demand for elective surgeries in the coming decades.
I’ve recently topped up on both of these stocks.
