How did billionaires make their money? Each one has their own story. But some of them, like investor Warren Buffett, made a lot of money by buying cheap shares in great companies, then holding them for the long term.
Could I do the same? While I may not achieve anything like the same results, I could at least adopt a similar approach to successful investors like Buffett, who has explained his strategy many times over the years.
What are ‘cheap shares’?
What is cheaper? A share selling for around 50p, like Lloyds, or one selling for closer to a pound, such as Centrica?
On that information alone, it is not possible to know. Price, after all, is different to value. As Buffett says, price is what you pay, but value is what you get.
So cheap shares are not necessarily ones that change hands for pennies, just as shares that cost £10 or £20 may not be expensive. Rather, value is about paying less for something than it is intrinsically worth.
Discounting the future
But if I buy a share, that means someone else sells it to me at the price I pay. So why would someone be willing to sell a share for less than it is worth?
The answer comes down to valuation, which is a highly subjective matter. Take electric vehicle maker Tesla as an example. Is the company cheap or expensive?
Based on today’s sales, it looks expensive. But few investors are buying into Tesla based on its current sales. Rather, they are trying to assess what might happen one year, five years, or a decade from now (Buffett has held some of his shares for over half a century).
Could Tesla revenues keep soaring as demand grows and new manufacturing capability comes online? Might price cuts eat into profitability, or will higher volumes to spread fixed costs across mean margins improve? Could areas like battery storages change the investment case for the carmaker?
Clearly, there is a room for a lot of different opinions about the ultimate value of a company like Tesla.
That is true for a lot of businesses. Such a situation is where I see an opening for me to buy cheap shares. If I can find a company with prospects I think are a lot better than many other investors realise, then perhaps I can buy it at a bargain price. Over time, doing that repeatedly could help me build a portfolio of blue-chip shares with attractive investment returns, just like Buffett has done.
On the hunt
That is the approach I am taking right now as I try to take advantage of unsteady stock markets to find bargains I can add to my portfolio.
With a long-term investing mindset, I am happy to buy shares in what I see as outstanding companies and hold them for years. First though, I need to identify such businesses – and what I think is an attractive price for them.
