I’d use the Warren Buffett approach to picking shares

I’d use the Warren Buffett approach to picking shares

Warren Buffett at a Berkshire Hathaway AGM

Image source: The Motley Fool

A lot of people hope to do very well in the stock market. But few have ever done quite as well as billionaire Warren Buffett.

Buffett is open about the investment approach he has honed over the course of many decades in the stock market. By using some lessons from his career, I hope I too can build wealth

Sticking to your knitting

Something striking about Buffett’s portfolio is that many of the names in it are huge, well-established companies such as Apple and Coca-Cola (NYSE: KO).

He does not put money into tiny firms in business areas he does not understand, hoping that they will turn out to be the next Nvidia or Amazon. Instead, he sticks firmly to business areas he understands and can therefore assess.

Putting money into something you do not understand is speculation, not investment. Like Warren Buffett, I aim to stick to my knitting.

Hunting for winners

Having landed on a broad area as an investment idea though, Buffett does not stop there.

There are lots of companies that manufacture soft drinks. So why did he choose Coca-Cola specifically?

Warren Buffett looks for what he calls a ‘moat’ – basically, something that differentiates a business from its competition.

In the case of Coca-Cola, there are quite a few such competitive strengths. For example, it has unique and well-known brands, a proprietary cola formula and a formidable worldwide distribution network.

Having landed on an area in which to invest, Buffett looks for what firms have the competitive strengths that can help them emerge as winners in that area.

Valuation matters

But while Warren Buffett still likes Coca-Cola enough to own the shares, he has not bought any more for decades.

The reason is not known to me but I suspect partly it is on valuation grounds. Coca-Cola shares cost far more now than when Buffett bought them in the 1980s and 1990s.

But the company faces risks. For example, growing health consciousness among consumers could hurt demand for sugary drinks, posing a risk to sales volumes. The shares do not necessarily look like the bargain now that they did when Buffett bought them.

Warren Buffett often talks about the importance of valuation when investing. Specifically, he describes himself as aiming to buy into great companies at an attractive price. I do the same.

Finding shares to buy

I think a lot of those Buffett lessons apply on both sides of the pond.

When looking for shares to buy for my portfolio, I stick to areas I feel I understand and try to identify companies that have a strong competitive advantage. I also consider the size of the potential customer market – how big is it today and what are its future prospects like?

I spread my ISA across a range of different such shares. Crucially, I focus not just on finding the right companies but also on buying them when their shares are attractively valued.

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