It’s fair to say that Warren Buffett knows how to invest. Since 1965, the stock market guru has generated a return of around 20% a year for his investors.
Here, I’m going to discuss how I’d invest £20k today using Buffett’s strategy. With a disciplined approach, I reckon I could turn the capital into £100k over time.
He focuses on quality
Buffett is often thought of as a value investor. However, these days, he is more of a ‘quality’ investor.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” he’s has famously said.
Now, when it comes to finding high-quality companies, one thing he looks for is long-term growth potential.
“Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher, five, 10, and 20 years from now,” he adds.
Another thing is a high return on capital (a measure of profitability). Companies that generate these consistently over time tend to be great long-term investments due to the fact they can compound their earnings.
As Buffett’s business partner Charlie Munger says: “If a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”
Finding Buffett-type stocks
Putting all this together, if I was to apply Buffett’s strategy today, my goal would be to find, and invest in, high-quality businesses that are very profitable and have substantial long-term growth potential.
Now, the good news is that one doesn’t need to look too far to find these kinds of companies. A great example, in my view, is alcoholic beverages giant Diageo (which Buffett owns).
It has plenty of growth potential due to the fact that it generates around 40% of its revenues in the emerging markets where wealth is growing rapidly.
It’s also very profitable. Over the last five years, return on capital has averaged 14.3%. And with the stock trading on a forward-looking P/E ratio of 19, it can be purchased at a ‘rational’ price.
Another good example is Visa (which Buffett also owns).
With trillions of transactions set to go digital in the years ahead, it has plenty of growth potential. And like Diageo, it’s very profitable (five-year average return on capital of 24.3%).
Meanwhile, with a forward-looking P/E ratio of 23, it’s not particularly expensive.
Turning £20k into £100k
How long would it take me to turn £20k into £100k using Buffett’s approach?
Well, assuming I built a well-diversified portfolio with 20+ stocks (to minimise stock-specific risks), I reckon I could achieve a return of around 9% a year over the long run (returns would vary from year to year). History shows that’s possible with stocks.
With a 9% return a year (and no setbacks), it would take me about 19 years to grow my £20k into £100k.
Of course, if I was to add to my investment on a regular basis, I could shorten the time needed to reach £100k significantly.
For example, if I was to invest another £5k a year, I could potentially hit the £100k mark in less than nine years.
