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The FTSE 100 is close to record highs at the moment. On the face of it, that makes it a strange time to be looking to buy shares in UK businesses.
Higher share prices means stocks are more expensive to buy. And this means lower returns for investors – there’s no getting around that.
I’m not letting the FTSE 100’s run up put me off investing in UK shares, though. While I wouldn’t buy the whole index at today’s prices, there are definitely parts of it that I think offer good value at the moment.
FTSE 100 stocks
Over the last decade, the FTSE 100 has returned an average of 6% per year. Some stocks, though, have done much better than others.
Croda International has returned 11% per year on average, compared to just 3.5% from British American Tobacco. Over time, that makes quite a difference.
If I’d invested £1,000 at 11% per year, my investment would be worth £2,839 after a decade. By contrast, if I’d achieved only 3.5%, I’d have just £1,410.
The lesson here is clear enough. Some of the individual stocks in the FTSE 100 have produced outstanding results even if returns from the total index have been more modest.
I take this to show there might be individual stocks that can do well going forward, even if the high price of the index today means its returns will be lower. The question is how to find those winning stocks.
Warren Buffett
Warren Buffett has had a terrific amount of success in finding stocks that perform better than the broader averages. The Berkshire Hathaway CEO is therefore a natural person to look to for advice.
According to Buffett, what makes a winning investment is one where the underlying business is going to grow in future. Share prices go up as a company’s earnings increase.
This is borne out by the FTSE 100 stocks above. Croda International’s earnings have grown by an average of 7% per year over the last decade, causing its share price to rise by around 9% per year.
British American Tobacco, on the other hand, has only increased its earnings per share by 3.5%. As a result, its price has actually fallen by 1% per year on average.
So the key is to identify businesses that can keep increasing their earnings. But finding these is not easy.
Should I buy Croda shares?
Often, companies that have grown their earnings impressively have something keeping competitors at bay. This allows them to keep growing into the future.
Given its past performance, it’s natural to wonder whether Croda has something like this. I think that’s a tricky question for a specialty cheimicals company.
A proper view of Croda’s prospects involves understanding how the markets it sells into are likely to develop. It also involves evaluating the chance of a competitor displacing its position in these markets.
I don’t yet feel qualified to make a judgement on those things, but this is a business I intend to find out more about. In the meantime, I’m looking for growing businesses in more familiar sectors.
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