The billionaire Warren Buffett has a lot to say about investing. Given his phenomenally successful track record over the long term, I think it can be worth listening.
A lot of it is pretty simple stuff. I do not think that makes it less powerful.
If anything, I think it actually makes it more powerful for a small private investor like me, as it is understandable and actionable.
For example, consider just one of Warren Buffett’s investing concepts: the “margin of safety“.
Building in some protection when investing
In the stock market, there are no guarantees. Even the best looking share can end up disappointing investors.
Then again, that very unpredictability makes the market what it is. While it can work against an investor, it can also go in their favour.
How many investors in small UK firm Filtronic five years ago could have foreseen its 3,083% share price rise until now?
Very few, I reckon – but I am sure they are delighted to have had their prescience rewarded so handsomely!
Warren Buffett has made some brilliant investing decisions – but he has also made some that, for whatever reason, did not work out well.
Still, he has been able to do better than he otherwise would have by looking for a margin of safety when investing.
In other words, he actively avoided some investments that he thought would work out well if there were no nasty surprises, in favour of ones he thought could hopefully still work out well even if there were some bumps along the way.
What does a margin of safety look like in practice?
A good illustration of that was Buffett’s long-term shareholding in Coca-Cola (NYSE: KO).
What could go wrong for a company like Coca-Cola? Lots actually, then as now.
Changing consumer tastes could hurt demand for sugary drinks. Soaring commodity costs could push up ingredient and production costs. A global footprint could mean that geopolitical and financial turbulence hurts trading in some markets.
But while those risks have come to pass in the past – and may do so again – Buffett recognised that the company had a strong margin of safety.
There is only one Coca-Cola brand. There is only one secret formula for the famous product, even though rivals may try to copy it. The company has other competitive advantages, too, like a best-in-class global bottling and distribution network.
Taken together, those strengths give Coca-Cola pricing power that helps generate attractive margins.
That, combined with a focus on a soft drinks market that benefits from enduring demand even if specific tastes change, give the company a margin of safety.
Last year, the company generated net income of $13.1bn on revenues of $47.9bn. That is a net profit margin of 27%.
That beefy profit itself gives the company a margin of safety. It could cut prices if it had to and still be profitable.
But at its current price-to-earnings ratio of 25, the Coca-Cola share price is too high for me to buy it even though I find the business model strong.
As I outlined above, the company (like any business) faces risks – and I like to feel a price offers me sufficient margin of safety for them when investing.
Fortunately, I reckon some other attractive shares offer me that right now.
Should you invest £5,000 in Coca-Cola right now?
When investing expert Mark Rogers and his team have a stock tip, it can pay to listen. After all, the flagship Twelfth Magpie Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.
And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Coca-Cola made the list?
Christopher Ruane does not hold any positions in the companies mentioned.
