Here’s What Billionaire Bill Ackman Would Buy if He Were Just Getting Started With $1,000

Bill Ackman is one of the most widely followed investment managers on Wall Street. He offers the chance to invest alongside him through Pershing Square‘s (PS -0.86%) funds, and he’s also forthcoming with commentary on the fund’s holdings and where he sees value in the market. He takes a long-term buy-and-hold approach to his investments, so investors can easily follow his best ideas based on his and Pershing Square’s public disclosures.

In a recent interview, he explained what he would do if he were just getting started with $1,000 to invest. The strategy is simple and straightforward, and the same approach he takes with the billions of dollars he manages for Pershing Square. He says he looks for three particular criteria in a potential investment: low leverage, a business he likes and admires, and a business he wouldn’t mind owning for the next decade.

Bill Ackman. Image source: Getty Images.

Keep leverage low

Ackman looks for businesses that aren’t overly reliant on debt to fund their growth. A low debt-to-equity ratio can be a quick filter for finding companies that meet the criterion. And strong and growing free cash flow can indicate that the company will remain self-sufficient without needing to tap the debt market to sustain operations.

Keeping the debt load low is important to Ackman because it makes the business much more resilient to economic downturns. He wants his economic exposure limited to the business’ operations. A credit or macroeconomic shock won’t impact a company with low leverage as much as it will affect a company with a lot of debt on its balance sheet.

The ability to consistently produce positive free cash flow is also extremely valuable for long-term investors. Cash flow in excess of capital needs or debt-servicing requirements gives a business greater optionality to make value-accretive moves, such as acquisitions or share repurchases.

A business you like and admire

The second criterion Ackman offers is qualitative. You should invest in businesses you “like and admire that make good decisions over time.”

This is reflective of Peter Lynch‘s advice to buy what you know. It’s important to understand the business you’re buying and the management’s decisions. That can be a huge advantage over other investors, even. “The consumer often has insights before Wall Street,” Ackman says.

If you can see demand for a product or service firsthand, it’s proof that the business is compelling. The next step is to review the business’ financials, returning to the first criterion.

It’s also important to remember that buying a stock is buying an ownership stake in a business. If you wouldn’t be proud to own the entire business, you shouldn’t be proud to own a tiny sliver of it.

You would still be happy to own it 10 years from now

Ackman echoes Warren Buffett in his final piece of advice. You should buy stocks that, if the stock market were to close for 10 years, you would still be happy to buy them today and own them a decade from now. At his investor meeting nearly 30 years ago, Buffett said that if you wouldn’t be happy buying a stock if the market were closed for the next five years, “you may not be focused on the proper things.”

Ackman said new investors get into trouble when they try to make money really quickly, with options and leverage and very speculative-type businesses. A slow, patient approach will usually work out better in the long run.

Allow compounding to work in your favor. Instead of trying to double your money quickly, consistently producing returns just slightly better than the S&P 500 can produce phenomenal results in the long run.

Finding a handful of businesses that meet the criteria above is all you need to put together a fantastic portfolio with just $1,000 to invest. Ackman practices what he preaches, too. Pershing Square’s funds invest in just 15 different companies, and he purposefully keeps the portfolio limited to that many names. He will sell existing positions to make room for new positions if he finds better opportunities. Keeping your portfolio small allows you to track your investments more closely and potentially produce those market-beating returns over the long run.