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Investing in UK stocks can be a great way to build wealth over time. He FTSE 100 has returned an average of 7.38% per year for the past decade.
That is a good result. But my goal is to do even better by following Charlie Munger’s advice.
charlie munger
Warren Buffett’s collaborator is a great font of investing wisdom. And one of my favorite ideas is the following:
It takes character to sit there with all that money and do nothing. I didn’t get where I am by chasing mediocre opportunities.
charlie munger
Munger’s point here is that achieving great returns means focusing only on really great investment opportunities. For above average returns, I need to buy shares in companies that are better than average.
But what makes a quality company? I’m looking for two things: a business that has a good competitive position and the ability to generate a lot of cash.
quality business
By these standards, I think Experian (BVL: EXPENDITURE) stands out as one of the highest quality British stocks. It generates a return on its fixed assets of around 386%.
For context, Diageo generates an 81% return, Microsoft manages 86%, and starbucks reaches 28%. These are all great companies, but Experian really stands out.
| operating income (thousands of millions) | net PPE (thousands of millions) | Return | |
|---|---|---|---|
| Diageo | £4.83 | £5.97 | 81% |
| Experian | $1.43 | $0.37 | 386% |
| Microsoft | $82.82 | $96.38 | 86% |
| starbucks | $4.43 | $15.58 | 28% |
In terms of cash conversion, Experian converts 90% of its operating income into free cash flow. That is also a very impressive result.
Microsoft manages to convert 72% of its operating income, Starbucks converts 57% and Diageo manages 43%. Once again, Experian stands out.
| Operating Income (bn) | Free cash flow (bn) | Scamversion | |
|---|---|---|---|
| Diageo | £4.83 | £2.09 | 43% |
| Experian | $1.43 | $1.28 | 90% |
| Microsoft | $82.82 | $59.62 | 72% |
| starbucks | $4.43 | $2.56 | 57% |
Valuation
Identifying quality businesses is crucial. But if I buy them at the wrong prices, I won’t be able to generate the kind of return I’m looking for.
In 2014, Experian shares traded at a price-earnings (P/E) ratio of 14. Since then, the shares have returned an average of 12.7% per year.
A year earlier, the stock was trading at a P/E of 22. If you had bought Experian stock back then, you would have achieved an annual return of just 8%.
This illustrates Munger’s point. If I take mediocre opportunities, I will get mediocre returns.
Patience
Following Charlie Munger’s approach is all about seizing rare opportunities. But with Experian shares trading at what I consider to be a high price right now, what should I do?
Waiting for lower prices is risky: the stocks I’m looking at may never reach the prices I expect. Similarly, buying weaker businesses or paying higher prices is likely to lead to lower returns.
I think a better plan is to keep learning about different stocks. The more quality businesses I have on my radar, the better my chances of finding one at a good price.
My investment plan is to focus on the best opportunities I can find. I may only own a few UK shares, but I believe this gives me the best chance of building significant wealth over time.
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