Warren Buffett learned long ago that it's worth 'paying up' for quality. From a practical point-of-view what this means is Buffett is prepared to pay fair value for a stock which he regards as possessing significant economic moats and competitive advantages. Under this approach, Buffett has to rely much more on future growth to provide the upside to his purchase price, rather than the upside coming from buying at a meaningful discount to fair value.
Then and now
In his early days, Buffett regularly purchased shares in lower quality businesses. When doing this he generally demanded a minimum margin of safety of 30% – or in other words – a 30% discount to his conservative assessment of fair value. As time went by, Buffett realised that quality businesses with defensive characteristics and predictable growth deserve a premium and are worth paying "more" for. These days, Buffett almost solely focusses on these types of investments.
Putting the long-term approach into practice
For investors whose aim from purchasing shares is to continuously add to their portfolio over their working lives and ultimately create a portfolio that will help provide them with a comfortable retirement, the following three top stocks are the types of stocks which at current prices could arguably meet Buffett's criteria.
ResMed Inc. (CHESS) (ASX: RMD) – the global medical devices firm is trading on a forward price-to-earnings ratio (PE) of 18. Its earnings are unfranked which makes them worth less to Australian investors than equivalent fully franked earnings, however its growth profile and sturdy balance sheet combine to make this an appealing investment proposition.
Sydney Airport Holdings Ltd (ASX: SYD) – the airport in Sydney is a highly appealing monopoly asset. The company's complicated financial structure also means Sydney Airport's earnings are unfranked, however the solid revenue base allows the company to pay a healthy dividend. An analyst consensus forecast provided by Morningstar has the company's dividend rising to 24.8 cents per share in FY 2015, placing the stock on a yield of 5.7%.
JB Hi-Fi Limited (ASX: JBH) – as a low cost operator, JB Hi-Fi arguably has a competitive advantage over its peers. If this moat is maintainable then the also out-of-favour stock could be offering a contrarian investment opportunity. With earnings and dividends forecast to rise, the stock trades on an attractive forward PE ratio of 14.
