Warren Buffett’s best advice – and two stocks to go with it

Warren Buffett: think carefully

Around 30,000 investors will flock to Nebraska this weekend to hear Warren Buffett’s latest words of wisdom at the Berkshire Hathaway annual meeting.

I’d love to be there myself; Buffett is often pretty funny. More importantly, I’d almost certainly learn something from the world’s top investor.

This weekend’s meeting has prompted me to think a lot about Buffett in the last few days. And my mind keeps going back to what I see as one of his best ideas – the ‘20-stock punchcard’.

Today I want to explain what this idea is all about. I’ll also highlight a couple of companies that I think would be good ‘punchcard’ stocks.

What is the investment punchcard?

Here is Buffett’s explanation of his punchcard idea:

“I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.

“Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do much better.”

Now I should say straight away that Buffett has made more than 20 investments in his lifetime.

So have I. Way more.

But I like the punchcard idea. Because I know that I’ve made too many investments ‘on a hunch’ in the past, without doing enough thinking or enough research. Sadly, many of these whim-driven investments didn’t work out well for me.

I’m not suggesting that you literally can’t invest in more than 20 shares during your lifetime. I just think it’s a good mindset to be in. You could pretend to yourself that you really don’t have many opportunities to invest.

Equally importantly, following this approach won’t just help you avoid disasters. It should also force you to invest for the long term and keep your trading costs right down.

An imaginary punchcard should encourage you to focus on your best investment ideas and back them heavily. Of course, you need to diversify – I certainly wouldn’t recommend you pile all your money into, say, just two stocks that you’re convinced are sure things.

But studies suggest that if you go much beyond a portfolio of around 16-20 stocks, you’re almost as well to simply invest in a tracker fund. The best active fund managers also tend to run very concentrated portfolios compared to their peers.

So as you get more experienced, I think you can start to back your best ideas more heavily. This is an especially attractive strategy if you invest in some passive funds at the same time to give you some broad stock market exposure.

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Two investments for my punchcard

The big question of course is: what would you buy if you only had room for 20 investments? Well, I’m going to suggests two stocks that I would buy if I was given an imaginary investment punchcard tomorrow – I should add that I own both of them already.

My first choice is Starbucks (Nasdaq: SBUX). I like Starbucks because it’s a very powerful brand with plenty of potential for further growth.

You might think that’s a ridiculous statement, given the number of Starbucks cafes that already exist in North America and the UK. But there are two things I’m particularly excited about.

Firstly, I think that Starbucks’ current programme to improve its food offer will deliver a significant boost to sales. You just need to look at the winners and losers in the pub sector to see what a huge difference better food can make to sales.

Secondly, I’m also excited by Starbucks’ Teavana business. Teavana is a chain of cafes and stores that sell high-end teas in North America. I visited a couple of Teavana outlets last month while on holiday and I was pretty impressed.  Teavana teas will soon to start to appear in some Starbucks cafes.

If you’re wondering – “who’s daft enough to shell out for a fancy cup of tea?” – then you just need to remember that people were saying exactly the same thing about coffee a decade ago.

I also liked Starbucks’ recent second quarter results. Same-store sales rose by 6% while total sales went up by 9%. Even better, earnings per share rose by 17%.  That was partly due to a rise in the operating margin to 15.1%.

Admittedly, Starbucks trades on a high price/earnings ratio of 26. But I’m happy to pay a full price for a global success story that should continue to perform well for many years to come.

This Big Pharma stock is a keeper

My second choice is GlaxoSmithKline (LSE: GSK). This drugs giant has increased its dividend payout every year since 1996 and currently offers a decent yield of 4.8%.

The crucial point is that Glaxo has an attractive drug pipeline. That means its prodigious cash flow should be sustainable in the long term. As Glaxo’s current drugs gradually lose their patent protection, new products should come through to replace them fairly smoothly.

Glaxo’s recent deal with Novartis is another plus point. Basically, Glaxo is swapping its cancer division in return for the Novartis vaccines division.  It makes sense for Glaxo to focus on its strengths, and boost its profits as a result.

In case you’re wondering, I doubt that any pharmaceutical firm will launch a bid for Glaxo as has happened with AstraZeneca (LSE: AZN). Glaxo is a fair bit bigger than Astra, and it would be tough for any company to absorb such a large firm.

But Pfizer’s bid for Astra does highlight that there is a lot of hidden value in the pharmaceutical sector, and that should eventually boost Glaxo’s share price.

So if I had a punchcard, I’d buy shares in Glaxo and Starbucks as my first two selections. Then I’d have to resist the temptation to buy anything else for some time to come.

By the way, if you like the idea of a 20-investment punchcard, then you should maybe take a look at our Dividend Letter investment strategy. It’s not explicitly based on Buffett’s principles, but the overall point is to build a low-stress, diverse but compact portfolio, that delivers a healthy income over the years. You can find out more about it here.

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  • Ed Bowsher

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    I very much hope GSK doesn’t get involved. I”d be surprised if they do.

    Ed

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