Investing in UK shares can be a great way of building wealth over time. The FTSE 100 has returned an average of 7.38% per year over the last decade.
That’s a good result. But I’m aiming to do even better by following Charlie Munger’s advice.
Charlie Munger
Warren Buffett’s collaborator is a great source of investing wisdom. And one of my favourite insights is the following:
It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.
Charlie Munger
Munger’s point here is that achieving great returns involves focusing on only really great investment opportunities. For above average returns, I need to buy shares in companies that are better than the 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 businesses
By these standards, I think that Experian (LSE:EXPN) stands out as one of the highest-quality UK shares. It generates a return on its fixed assets of around 386%.
For context, Diageo generates an 81% return, Microsoft manages 86%, and Starbucks achieves 28%. These are all terrific companies, but Experian really stands out.
Operating Income (bn) | Net PPE (bn) | 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’s also a very impressive result.
Microsoft manages to convert 72% of its operating income, Starbucks converts 57%, and Diageo manages 43%. Once again, Experian sets itself apart.
Operating Income (bn) | Free Cash Flow (bn) | Conversion | |
---|---|---|---|
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 returns I’m looking for.
In 2014, Experian shares were trading at a price-to-earnings (P/E) ratio of 14. Since then, the stock has gone on to return an average of 12.7% per year.
A year earlier, the stock trading at a P/E ratio of 22. If I’d bought Experian shares back then, I’d have managed an annual return of just 8%.
This illustrates Munger’s point. If I take mediocre opportunities, then I’ll get mediocre returns.
Patience
Following Charlie Munger’s approach involves only taking outstanding opportunities. But with Experian shares trading at a price I consider high at the moment, what should I do?
Waiting for lower prices is risky – the stocks I’m watching might never reach the prices that I’m hoping for. Equally, buying weaker business or paying higher prices is likely to lead to lower returns.
I think that 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 investing plan involves focusing on the best opportunities I can find. I might only own a few UK shares, but I think this gives me the best chance to build significant wealth over time.
The post I’m following Charlie Munger’s advice to target getting rich with UK shares appeared first on The Motley Fool UK.
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Stephen Wright has positions in Experian Plc. The Motley Fool UK has recommended Diageo Plc, Experian Plc, and Microsoft. 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.