Warren Buffett and Charlie Munger agree that the key to investing is to invest only in the very best opportunities available. Having 10 investment ideas and putting money into the tenth one instead of the first or second one is a mistake. Charlie Munger puts the point like this:
Warren [Buffett] always says that if you lived in a growing town and you owned stock in three of the best enterprises in town, isn’t that diversified enough? The answer is of course it is—if they’re all wonderful places. […] The whole idea of diversification when you’re looking for excellence, is totally ridiculous. It doesn’t work. It gives you an impossible task.Â
The most recent 13F filing from Berkshire Hathaway, however, reveals that the company has around 46 investments in US stocks. Buffett and Munger therefore do own a diversified portfolio. So how should an investor like me think about diversification?
The answer is that I should try to build a diversified portfolio of stocks over time. And I should do this by buying whatever I think are the best stocks for me to buy at the current time. If the most attractive stock for me to buy right now is Berkshire Hathaway, then I should buy Berkshire Hathaway shares right now. But Berkshire won’t always be the most attractive investment opportunity on the market. When something else, such as Legal & General is the most attractive investment opportunity, I should add Legal & General shares to my Berkshire Hathaway holdings. The question is, what should I buy first?Â
Where to start?
I have two ideas to get started. The first is Howden Joinery Group (LSE:HWDN). The second is Rightmove (LSE:RMV). At the moment, these stocks look equally attractive to me, so I’d probably start my portfolio with investments into both of these.
Howden Joinery Group supplies UK homebuilders with kitchen and joinery products. This investment looks risky given the high price of commodities, but there are three things that attract me to this company. First, the company is in a strong financial position. The interest it pays on its loans takes up only 1.34% of its operating income. Second, the company trades at an attractive valuation. It has a market cap of just over £4.6bn and generated just over £300m in free cash flow last year. Third, the company is efficient. Its returns on invested capital are in double-digits and have been consistently over the past five years.
Rightmove is the UK’s largest online property platform. Unlike Howden Joinery, the stock is currently expensive, which presents an investment risk. But I think that the underlying business is arguably the best in the UK, which means that I would buy it today if I were building a portfolio of UK stocks. Like Howden Joinery, Rightmove is in an extremely strong financial position. The company’s current assets comfortably cover its long-term liabilities. It has also been growing fast. Retained earnings have increased from just over £11m in 2018 to just over £133.25m by the end of 2020. The company’s size also gives it a huge advantage over its competitors, making it hard to disrupt.
If I were looking to build a portfolio of UK stocks in the style of Warren Buffett and Charlie Munger, I’d start by buying shares in Rightmove and Howden Joinery Group.