The annual release of the Warren Buffett letters always makes headlines. The Sage of Omaha offers up free advice based on his legendary investing prowess. Here is an example of one share I’d pick based on what I’ve learnt from Buffett’s missives.
Warren Buffett letters emphasise pricing power
One of the reasons Buffett has gotten so rich is his expertise in spotting the difference between what it costs to produce something and the price at which it can be sold.
Think about gas as an example. It’s basically a commodity – if you price your gas above the market rate, customers can just shift their purchase to a competing gas company. With a unique brand, by contrast, a company can gain what is known as ‘pricing power’. That means it is able to charge more for their product or service. Pricing power is obviously important as a way to enable more attractive profit margins for a business.
Buffett’s holding in Coca Cola shows the principle in action. While the ingredients are inexpensive, Coke’s unique recipe and branding allows it to achieve attractive margins for its sugared water. Warren Buffett letters across the years praise Coke for the durability of its franchise.
A UK pick with pricing power
Applying this principle directly, there are several UK shares which catch my eye.
For example, one could consider Coca Cola HBC. The London-listed company is one of Coke’s bottlers. From its Greek roots – the “H” in its name stands for Hellenic – it now operates across multiple European markets, including Ireland.
But instead of looking at a bottler, I am more tempted to look at a brand owner close to Coke itself. As a bottler, it’s hard to make money without bottling and selling drinks. But a brand owner can use the long-term power of its brand building to make it into the future, a clear attraction highlighted in most years’ Warren Buffett letters.
One company that comes to mind is AG Barr (LSE: BAG). This Glasgow-based purveyor of sparkling drinks is famous for its iconic Irn-Bru drink. The orange-coloured carbonated beverage is very popular across Scotland, where for decades it has vied with Coke for the top spot. But it is not limited to Scotland – Barr has worked to make inroads into the market in England too.
Too much focus on one revenue source can make a company vulnerable. The company has a portfolio of other drinks which allows it to make more efficient use of its distribution network, although its key brand remains Irn-Bru.
Clearly the pandemic took some shine off the company, which said last month its full-year revenue would fall around 11%. It suspended the dividend last year, although it expects to reinstate it this year.
The shares are trading on a price-to-earnings ratio of 19, which isn’t cheap. But the Warren Buffett letters emphasise that it’s better to pay a good price for a great company rather than a great price for a good company.
Is Barr a great company? Its recent performance has disappointed a little, but its strong Irn-Bru brand gives it the sort of pricing power and longevity Buffett loves. I’d pick it as the sort of company Buffett principles would lead me to buy.