Warren Buffett’s favourite valuation test, the “economic moat”, can work wonders for your portfolio, history suggests
There are many ways private investors can value a share or
stock market to work out whether they are picking up a bargain or
making an expensive mistake.
Popular measures include the price-to-earnings ratio, which
compares a company’s market value with its profits.
Another is the price-to-book ratio. This measure examines
how a company’s market value compares with the value of its
There are many others, such as the “Cape” ratio (p/e with
earnings averaged over 10 years) or simply looking at the
dividend yield, so knowing which ones to follow and trust can be
a bit overwhelming.
One option is to shelve these measures and use Warren
Buffett’s favourite valuation test – the economic moat.
This concept, coined and popularised by Mr Buffett,
identifies companies that are immune to competition, so are therefore price makers rather than price takers.
In having this advantage, the theory is that these companies are more likely to consistently grow their earnings and profits,
which should handsomely reward long term investors.
The way Mr Buffett works out which companies have a “wide
moat” is more of an art than an exact science.
Mr Buffett looks for companies that score well for having a
well-known brand name, pricing power and companies that have
US shares that fit the bill, which Mr Buffett has held for
several years, include Coca Cola and Procter & Gamble, which owns
Gillette razors and Fairy Liquid.
But what about the British shares that pass Mr Buffett’s
test? We asked Morningstar, the data firm, to come up with ten
shares with the “widest moat” out of all the 600-odd companies
that are listed in the FTSE All Share index.
As the chart below shows an investor who held all ten shares
in a “Buffet UK portfolio” with a 10pc weighting in each, would
have beaten the FTSE All Share over the past five years. Below
the chart we name the ten shares.
Buffet UK portfolio return: 96pcs. FTSE All Share return: 29pc
The ten shares that pass the Warren Buffett test
Morningstar placed particular emphasis on a company’s
prospect of earning an above-averagereturn on capital and firm’s
that posses a competitive edge that holds competitors at bay.
The ten shares that scored the highest are all familiar
GlaxoSmithKline, came out on top, scoring the “widest moat”.
In second place is British American Tobacco, followed by another
drug firm AstraZeneca.
The rest of the top ten includes drink firms Diageo and
SABMiller. Followed by consumer goods giant Unilever, Imperial
Tobacco Group and ARM Holdings, which makes chips for smartphones.
Completing the top ten are Experian, the credit checking
agency, and Burberry Group, the luxury fashion chain.
How the shares have performed over five years
Alex Morozov, a research director for Morningstar, who
helped compile the research, said: “These shares may not be the
heapest on other metrics but they offer investors a margin of
safety because these are businesses which are still going to be
around in twenty years time and will still be profitable,” Mr
“Mr Buffet’s strategy has been extremely successful with US
shares and this can be replicated in other stock markets. The ten
shares are companies which Mr Buffett would be naturally drawnto.”
Companies that score badly on Mr Buffett’s measure are those
without intangible assets, such as miners and resource firms.