10 UK shares Warren Buffett might put in his ISA in 2023

In his recent letter to shareholders, Warren Buffett remarked on staggering long-term growth in dividends and share prices at a handful of his company holdings. Stock screen expert Ben Hobson identifies companies that fit Buffett’s strategy and discusses lessons from the master that might make you a better investor.

When it comes to highlights in the corporate calendar, Warren Buffett’s annual letter to shareholders of Berkshire Hathaway (NYSE:BRK.B) is one of the most closely watched.

Buffett has been running Berkshire for 58 years. And together with his business partner Charlie Munger, he’s made a few mistakes plus some very, very good decisions in that time.

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Today, Berkshire is one of the largest corporations in the US. In the size stakes, its market capitalisation of $672 billion makes it larger than Tesla (NASDAQ:TSLA) but smaller than Amazon (NASDAQ:AMZN).

The group owns substantial businesses in sectors like insurance, railroads and energy, and has interests right across the economy.

It also has significant stakes - or ‘part ownerships’ as Buffett calls them - in several public US companies. They include giants such as American Express (NYSE:AXP), Bank of America (NYSE:BAC), Chevron (NYSE:CVX), Coca-Cola (LSE:CCH), HP (NYSE:HPQ), Moody's (NYSE:MCO), Occidental Petroleum (NYSE:OXY) and Paramount Global (NASDAQ:PARA).

Recreating the success of an approach like Buffett’s is a holy grail in investing. But the truth is that much of its success lies in good choices made decades earlier that were left to compound.

But that doesn’t mean there aren’t lessons to take from this exceptional success story.

What Buffett’s latest letter says…

Buffett’s letters are a gold mine of investing wisdom. You could learn all you need to know about the concepts of quality, valuation, moats, compounding and business operations on the pages of his annual reviews.

This year’s letter to Berkshire’s shareholders is shorter than normal. It is also slightly different to what we’ve been used to in the past. You could say it reveals something new about the way Buffett thinks these days. After all, he’s 91 years old, and Munger is 99.

Most watchers of Berkshire realise that the transfer of management at the top has shifted from Buffett and Munger to the hands of successors like Ajit Jain and Greg Abel. And while Buffett still calls the shots, this latest letter feels more reflective than usual.

Gone are the deep dives into the detail of subsidiary holdings and operations. They’re found in the much larger annual report. In their place are some simple lessons on why Berkshire’s approach has worked so well and what future investors can learn from it.

Here are some of those lessons:

• Invest in businesses, not stocks

Buffett says the aim is to make meaningful investments in businesses with long-lasting favourable economic characteristics and trustworthy managers. The message here is to buy the ‘business’ not the ‘share price’. As he says: “That point is crucial: Charlie and I are not stock-pickers; we are business-pickers.”

• Nothing is certain, and luck is important

Despite his focus on picking businesses, Buffett owns his mistakes. He says: “In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so. In some cases, also, bad moves by me have been rescued by very large doses of luck.”

• You only need to make a few good decisions

Buffett’s experience shows how a few big winners can transform your wealth. For example,

Berkshire spent $1.3 billion buying shares in Coca-Cola in the seven years up to 1994. That year the dividend paid on those shares was $75 million. Last year the payout had risen to $704 million. As a result, Coca-Cola was, and remains, 5% of Berkshire’s net worth.

Buffett says: “These dividend gains, though pleasing, are far from spectacular. But they bring with them important gains in stock prices.”

The point here is that while the scale of this investment is unthinkable to most of us, the choice of Coca-Cola as a highly profitable long-term business made a big difference over time.

Investing with a focus on compounding returns

How do you use these lessons to your advantage?

Warren Buffett inspired stock screens tend to come in many flavours. But if you want to capture the spirit of his approach, the broad idea is to focus on companies with high profitability indicators over time. These shares can become expensive in different market environments - and it’s important to remember that Buffett would not want to overpay.

In this week’s Buffett themed screen, I’ve included a focus on:

• High five-year average free cash flow margins (greater than 10%)
• High five-year average return on capital employed (ROCE) (greater than 15%)
• High five-year average operating margins (greater than 15%)

But as a nod to Buffett’s recent commentary on dividends I have narrowed the range to pick up companies with a track record of:

• Paying dividends for more than 10 years
• Growing dividend payouts for more than nine years

Here are some of the results:

Source: SharePad

At first glance, almost all the shares here trade on forecast price-earnings (PE) ratios reaching well above 20x. The highest are at steam management group Spirax-Sarco Engineering (LSE:SPX) on 31x, and safety equipment specialist Halma (LSE:HLMA) on 29x. So this is territory where investors are potentially having to pay up for quality, although several are still way off their one-year highs.

It’s the quality that really stands out in this list. As a business picker, quality can be found in high average returns, with measures like return on capital and operating margins. These are particularly appealing in inflationary environments, where profits are at risk of being eroded.

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Asset management is a high margin sector, and you can see that in the 30-plus figures at Impax Asset Management (LSE:IPX) and Liontrust Asset Management (LSE:LIO). Information and analytics group RELX (LSE:REL) is another high margin firm, but even the more specialist industrial businesses here look solidly profitable over time.

In terms of dividends, there are clues that they are all consistent payers, although note that the yields on these stocks are generally unremarkable. That isn’t necessarily a problem for Buffett-style investing, where the most important factor is that the company is allocating cash as effectively as possible - either to growth, pay dividends or buyback shares.

Overall, technical products company Diploma (LSE:DPLM) leads the list on dividends with a 31-year record of payouts, 22 of which have seen its dividend grow.

Lessons from the world’s best investor

So what can we learn from this year’s letter from Warren Buffett? It’s a reminder that a few good choices, good luck, longevity and an uncanny ability to weather the course over the long-term are all winning traits. It’s much easier said than done, which is why Buffett, Munger and Berkshire are so unusual.

However, Buffett’s focus on the quality of the business (without overpaying for its shares) is a lesson that all investors should bear in mind. As always, he puts it better than anyone else:

“The lesson for investors: The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.”

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.