And yet, when the economy’s in such a ruinous state, the challenge of navigating an increasingly complex market can oftentimes seem insurmountable.
But fear not. There are plenty of tried and true methods for identifying which companies make for excellent long-term investments, and, in this article, we’ll go over 7 of the most important.
So, without further ado, let’s begin.
1. Margin of Safety
If a business can attain a reasonable margin of safety, it means it can absorb some losses and still remain profitable. This gives the company flexibility, making it less likely to go out of business in the event of an economic downturn.
What’s more, having an adequate margin of safety ensures a company can withstand any problems throughout its business cycle. The firm gains a sense of security, allowing it to make long-term plans with greater confidence.
And when companies have faith in their future, they invest more in R&D, expand their workforce, and make other strategic decisions that can lead to growth and improved financial performance.
2. Economic Moat
An economic moat is a competitive advantage that gives a company an edge over its industry rivals.
A moat can come about due to cost structure efficiencies, brand recognition
, superior distribution channels, or any other factor that confers precedence in the space.
The metaphor of a moat implies a company enjoys some protection from the challenges to its market share. Furthermore, finding a business with a solid moat is vital for long-term growth, as it nurtures profitability and promotes inward investment into the firm.
A good stock should have a valuation that reflects a company’s underlying worth.
In theory, a business ought to have a rating that’s not so low as to be a value trap
, but not so high that it appears overly expensive either.
And because a company’s valuation can change, it’s essential to keep an eye on the market to ensure it remains accurate and up to date. Some good valuation metrics include the price-to-earnings multiple (P/E) and the enterprise value-to-revenue (EV/R) ratio.
Indeed, the P/E multiple measures how much investors are willing to spend for every dollar of a company’s earnings. A higher fraction means that investors are willing to pay a premium for the stock, suggesting the firm will increase its earnings relative to its current profits over time.
However, a high P/E multiple might imply the stock is overvalued, and that its share price could go down rather than up.
Alternatively, the EV/R multiple measures a company’s enterprise value compared to its top-line revenue. This metric can be a good way to compare companies operating in the same industry, giving you a relative indication of how one business is faring against others in the sector.
When building an investment portfolio, several factors must be taken into account in order to achieve your best results.
One important decision to consider is what fraction of your total investment should be attributed to each particular stock. This largely depends on the level of diversity within your portfolio and the number of stocks you intend to include.
For example, holding just one stock exposes you to greater risk than if your portfolio was comprised of different companies spanning multiple sectors. This is due to the fact that, if a single company experiences severe financial difficulties, your entire investment could be lost. However, owning shares in several companies helps protect against such losses, as other holdings may offset any negative movements in one or more of your positions.
Furthermore, thought should be given to how volatile each individual stock happens to be.
For instance, on the one hand, adding volatile stocks to your portfolio can be a great way to boost your potential returns, since they generally outperform the market when the market’s on the way up.
However, you should be aware of the risk this entails. These stocks tend to see greater swings in price than the overall market and, as such, they can experience larger losses as well. Therefore, it’s important not to let volatile stocks make up the majority of your portfolio so that you can protect yourself from significant losses.
5. Correlation to the Wider Economy
How company performance correlates to general economic growth is also a key determinant for long-term investing success.
For example, stock market trends often act as a leading indicator of economic health. Indeed, strong economies seem to be good for stocks, while weak ones tend to put downward pressure on commodity and equity prices.
That’s why it’s crucial not just to pay attention to stock market valuations in isolation, but to take into account the bigger picture, such as GDP growth, inflation, and unemployment
On top of that, some economic conditions impact stock prices in more specific ways. Take, for example, the threat of a looming recession. This could lead not just to a general reduction in spending, but also a decrease in overall business investment too. Furthermore, this could precipitate lower profits and, as a result, lower stock prices as well.
6. Corporate Leadership
Leadership is another critical component in the success of a business too. It provides strategic direction, establishes the cultural tone of a company, and, in the end, has an influence on bottom-line profitability too.
For example, under Tim Cook’s stewardship, Apple grew its stock price by 1,200% during his first ten years on the job, going on to become the largest publicly-traded company in the world.
Moreover, leaders who are able to create a shared vision and a sense of purpose among their employees are more likely to motivate them to achieve great things. Conversely, poor leadership can result in decreased productivity, high turnover rates, and low morale.
7. Exogenous Risks
Exogenous risks can affect stock market performance because they are almost entirely outside a company’s control.
Political instability, natural disasters, and changes in global markets can all lead to detrimental consequences that have negative effects on prices.
While a company may be able to hedge against some of these risks, others may be impossible to second-guess. This makes exogenous risk one of the most difficult types of risk to manage and predict.
However, there are some ways to assuage potential problems, even if all eventualities can’t be anticipated or foreseen.
For instance, legal risk
can be mitigated by ensuring contracts are compliant with relevant laws and regulations, while technological risks associated with new developments can be alleviated through the use of insurance, early adoption of technology standards, and development of in-house expertise.