This brilliant piece of Warren Buffett advice is transforming how I buy shares

Every time Harvey Jones catches up on Warren Buffett he learns a new lesson about investing. He also learns what he’s been doing wrong.

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Millions of investors pore over the wit and wisdom of billionaire investor Warren Buffett when deciding which shares to buy.

During recent volatility, many will have had the second part of his most famous mantra ringing in their ears: “…the time to be greedy is when others are fearful”.

The panic was a brilliant time to buy UK shares at reduced prices.

Yet Buffett’s advice doesn’t just ring true in a crash. I try to apply it whenever I buy shares. Especially this nugget: “For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favourable business developments.”

FTSE 100 bargain?

I hate overpaying for shares. Unfortunately, it’s not as easy as Buffett makes it seem. One year ago, I decided US chipmaker Nvidia was overhyped and overpriced so didn’t buy it. I’ve missed out on a 130% gain as a result.

Created with Highcharts 11.4.3Nvidia PriceZoom1M3M6MYTD1Y5Y10YALLwww.fool.co.uk

At the same time, I decided FTSE 100 insurer and asset manager Legal & General Group offered an attractive purchase price, trading at around six times earnings. The shares are down 5.08% over 12 months. At least I can console myself with its 9.27% trailing yield.

Created with Highcharts 11.4.3Legal & General Group Plc PriceZoom1M3M6MYTD1Y5Y10YALLwww.fool.co.uk

Obviously, I can’t determine the success of an investment over such a short timescale. Plus I’m hardly comparing like with like. But now I’ve come across another Buffett snippet, it’s made me think twice.

The ‘Sage of Omaha’ said: “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now.”

I believe I bought Legal & General Group at a “rational price”. I also think that selling pensions, annuities, index trackers and protection makes this an “easily understandable business”.

But are its long-terms earnings “virtually certain to be materially higher”? I’ll confess, I didn’t really look. I just kind of hoped. Just one reason why Buffett’s worth $130bn and I’m not.

L&G’s earnings have been patchy over the last decade. Up and down rather than “materially higher”. Let’s see what the charts say.


Chart by TradingView

This morning we learned that its first-half profits rose 1% to £849m. That beat forecasts but is far from stellar. Profit after tax fell 40.8% to £223m.

L&G operates in a competitive market. It’s also a mature market. While Britons need to dramatically increase their pensions and protection, they don’t have the cash. This puts a ceiling to UK growth prospects.

First-half annuity sales more than doubled to £1.2bn thanks to higher interest rates. Unfortunately, they’re likely to slow as rates retreat. The emerging bulk annuity market offers better growth prospects. The board’s also taking a shot at the world’s biggest insurance market – the US. That offers real growth prospects, but competition will be intense.

Admittedly, I don’t think Buffett would touch L&G based on its earnings outlook. At least I’ve learned a hugely valuable lesson. And I’ll still get my dividend income.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones has positions in Legal & General Group Plc. The Motley Fool UK has recommended Nvidia. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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