If your goal is to build up a £1m+ ISA portfolio, you need a solid investment strategy. Not only will you need to invest in stocks and funds that increase your wealth over time, but you’ll also need to minimise the chances of losing large amounts of money as capital preservation is vital when it comes to building long-term wealth.
With that in mind, it could be a sensible idea to look at how Warren Buffett – who is probably the greatest investor of all time – has built his fortune. Here’s a look at three things Buffett focuses on when picking stocks for his portfolio.
One of the first things is a strong competitive advantage or, as he calls it, an ‘economic moat’. This could be a strong brand, a technological advantage, a patent, or plenty of other things. The key is that it puts the company in a favourable position and helps it outperform its rivals.
“The most important thing is trying to find a business with a wide and long-lasting moat around it,” Buffett says. “Why is that castle still standing? And what’s going to keep it standing or cause it not to be standing five, 10, 20 years from now?”
Looking at the , companies such as Unilever (LON:) and Diageo (LON:), which have strong economic moats due to the power of the brands they own, have certainly been excellent investments over the years.
Return on equity
When analysing companies, one ratio that Buffett likes to assess in particular, is return on equity (ROE). This is a measure of a business’s profitability and can be used to compare other companies in the same industry. It’s calculated by dividing a company’s net income by its total equity. Buffett likes to see a ROE ratio of at least 8% over a 10-year period.
Many companies in the FTSE 100 that have high ROE ratios have delivered impressive returns over the years. For example, shares in Rightmove, which has a five-year average ROE of a spectacular 1,618%, have risen around 125% over the last half-decade. Similarly, shares in Hargreaves Lansdown (LON:), which has a five-year average ROE of 68%, have climbed nearly 80% over the last five years.
ROE alone won’t guarantee investment success, however, but used in conjunction with other ratios, it’s very useful.
Finally, Buffett also pays close attention to debt. The reason for this is that low debt gives a company the flexibility to navigate the ever-evolving business environment. By contrast, a company with a huge pile of debt can get into trouble when business conditions are unfavourable.
Certainly, some high-debt FTSE 100 companies have been terrible investments in recent years. For example, BT – which is loaded with debt – has seen its share price fall nearly 60% over the last three years. So debt is definitely something to keep an eye on.
Of course, these are just three components of Buffett’s investment strategy. There are many more. However, if you’re looking for stocks to help build up a £1m+ ISA, they could be a good place to start.
Edward Sheldon owns shares in Unilever, Diageo, Hargreaves Lansdown, and Rightmove. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended Diageo, Hargreaves Lansdown, and Rightmove. 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.
Motley Fool UK 2019