Trying to find the best UK shares can seem like a pretty tough ask to new investors. Rather than suffer from information overload and analysis paralysis however, I think there are a few key things to look for.
Find the moat
The best businesses usually do something others don’t, or struggle to replicate to the same standard. They’re also able to protect and exploit this advantage over a long period of time. As Warren Buffett regularly advises, you need to find stocks with strong ‘moats’.
A moat can take many forms. A company may be a leader in a niche market, supply services to a huge number of clients and/or have desirable brands that customers can’t (or won’t) switch away from.
If you can’t identify a firm’s advantage, it’ll probably be harder to make money from its stock.
Financially sound
Taking on debt isn’t necessarily a bad thing. Used appropriately, it can turbocharge growth during good times. That said, a great company is usually not one loaded up to its eyeballs in borrowings.
One of the first things I check when running the rule over any potential investment is whether it has more debt than cash. If so, I’ll likely want to find out how quickly this needs to be repaid and the plan for doing so.
Ideally, any stock you buy will have net cash. This should make it more resilient to setbacks that can’t be foreseen… the coronavirus pandemic being a perfect example.
More bang for your buck
The best UK shares/businesses make excellent returns on the money they invest. In financial jargon, this is the return on capital employed (ROCE). Think of it as the interest rate that a company earns on its money, just like a rate you’d get in a savings account. Anything over, say, 20% is very good.
Buffett is a big believer in ROCE. So too are top fund managers Terry Smith and Nick Train. They know a company that’s able to compound in value by reinvesting profits can make you rich, even if you pay a high (but not excessive) price for its stock.
Motivated management
Human nature dictates that we’re more likely to put effort into something if we stand to benefit from its success. This is why I always look to see whether those running a company own its stock. Any indication that directors aren’t just working for the monthly payslip grabs my attention.
The identity of major shareholders can usually be discovered through a company’s investor relations site, or via a simple online search (here’s an example). Inevitably, levels of ownership change over time so be sure to keep up to date with any announcements relating to director buying or selling.
A route to growth
As good as all the other points are, the best UK shares tend to be those with a pathway to growth. Being a market leader in something no one wants isn’t ideal. Having a lot of cash can also be a problem if there’s no plan for using it.
This is why it’s important to keep up to date with major trends and companies at the forefront of capitalising on them. If you can tap into these stocks before the herd arrives, the rewards could be substantial.
