If I could be granted one investing super power, it would definitely be picking the right stocks to buy and hold for the long term. However, none of us have a crystal ball to be able to pick the right stocks or time the market.
So how do you set yourself up with the best of the best stocks for the long run?
I’ve been evaluating different strategies for long term sustainability, and I am confident that if you want an investing strategy that requires minimal maintenance, you need to pick great stocks to buy and hold for the long run.
So what criteria should you use to create a watch list of some of the best stocks?
- Companies which have a share buyback program
- Companies which have healthy sales and EPS growth CAGR (2 – 3 year)
- Companies that are trading at reasonable current or forward PE ratios
- Companies with a potential for their stock to execute a forward split
- Companies that trade within a tight variance such as their +/- 1 st dev trendline channel
Share buybacks
I love companies that buyback shares because it’s a vote of confidence in the long term value this company believes it will create for shareholders. I see this as an insurance policy as well, that the more the company reduces it’s shares outstanding, the more likely it should be able to continue delivering on EPS expectations.
Healthy Sales and EPS Growth
Companies that have a reliable revenue stream and strong EPS results history are the top of my list. Past performance doesn’t indicate future results, however for me this is an absolute must. Historical track record is important too which is why I look at a 3 year CAGR growth rate. Looking at what analysts are projecting EPS to be for the year ahead, whether analysts are revising forecasts higher, and how often the stock delivers against or exceeds EPS expectations.
Reasonable PE ratios
If a great stock is trading at high current PE ratios, it will remain parked on my watch list until the stock comes down to a level I feel comfortable buying it at. I also look at the current stock price relative to the EPS growth that the company is forecasted to deliver for the year ahead to determine if the stock is a buy.
Forward stock splits
The best way to gauge whether this is a possibility is whether the stock has ever historically issued a forward stock split. I see these as wealth multipliers if the company will continue to deliver strong results for many more years following a forward stock split. If you are not familiar with this concept, in very simple terms assume the following example:
- Initial investment: you buy 10 shares of a stock trading at $100 = total book value cost of $1000.
- The stock goes up to $1000 and the company issues a 10:1 stock split. This is a net neutral exercise in the company maintaining it’s market cap, however the share price becomes more nominally affordable for everyday retail investors.
- Investment value before the 10:1 stock split: 10 shares * $1000 per share = $10,000 (a 10X return on your investment)
- Investment value after the 10:1 stock split: 100 shares * $100 per share = $10,000 (a 10X return on your investment)
The market value of your investment has not changed, however, imagine if the stock runs up to $1,000 per share again. At that point, your investment would be worth $100,000 (100X your original investment). If you look at how many times MSFT issued forward stock splits, it did not require much of an initial investment to become a millionaire from that 1 stock alone.
Companies that trade within a tight variance
I always verify the volatility of a stock to understand whether I am looking at a stock with high volatility, or a stock that trades within a controlled range. I see this as another insurance policy that investors see long term value in the company. As long as the underlying business continues to perform, if the market drives the share price lower (for whatever reason), at some point investors will come in and create new support for the stock driving the share price higher. By extending the trendline channels out another year, I can also model out potentially where the share price could be and based on historical pull backs also assess the risk if I am buying the stock at the current price. I also like to look at stocks that are in an uptrend, however there are exceptions to this rule for companies with strong business have been trading sideways and range-bound. I always assess the underlying business for long-term potential growth first and foremost.
Takeaways
This is not meant to be an exhaustive list, however I strongly believe looking for these criteria help to protect your portfolio over the long run. Of course beyond this, there are other components that could be great qualifiers such as whether the company pays a dividend, how well it can recover from economic hardships, how well it is positioned to win in the industry it competes in. Add your own criteria as you continue to refine your own investing approach.
The next most important thing once you have a watch list of stocks you believe to be the best of the best, is to determine the price at which you are comfortable buying the stock at. If you’re comfortable buying at the current price, then go ahead and welcome the stock into your portfolio BUT REMEMBER TO BE DISCIPLINED WITH YOUR ASSET ALLOCATION towards each position within your portfolio. If you believe the stock price needs to come back lower in order for you to get in based on your valuation modelling, then keep it on your watch list in the event the share price comes down and/or your valuation model changes to justify buying the stock at a future point in time.
Happy investing!