Investing in stock markets is one of the few ways one can accumulate wealth over a long period of time. Even though there is a level of risk associated with the markets, one can mitigate this risk by carefully picking the stocks. Countless investors have become millionaires by making the right picks and there is no reason as to why you cannot join that club!
Each investor will have his own strategy to select a company but generally speaking, here are the five things that you should look for in a stock for long-term investment:
You can easily explain to an elementary student how the company makes money
This point may sound a bit ridiculous, to begin with, but you will be surprised to know how many people have lost their hard-earned money by investing in companies that they didn’t understand. When it comes to investing in the markets, you should always invest in companies which are simple to comprehend. As a general rule of thumb, if you can explain how the company generates its profits with just a crayon and a small paper, then the company can be considered for further analysis.
For example, you have ITC Limited, which is a market leader in the FMCG and tobacco segment. Similarly, you have Maruti Suzuki – the largest automobile manufacturers in India. It is easy to understand how these companies make profits and over the years, their shares have reflected the same sentiment.
The company is financially strong
This one is a no-brainer. A company that has done well financially over the years and continues to do so makes for a much attractive pick than a company that is struggling. In order to judge the financial health of a company, the things you need to consider are revenue, profit margin, and debt.
While daily stock movements are governed by a host of factors, the long-term movement is decided primarily by the revenue growth of the company. If a company’s income has increased like clockwork, then it is considered to be a good sign. Furthermore, if the company is able to generate steady income without increasing its expenses, then its profit margins are bound to improve. For this reason, you should also look at the expenses of the company. You can find this information in the balance sheet which is updated on a quarterly basis.
Similarly, you should also look at debt. Many companies tend to borrow large sums of capital to run their operations. The stock price of a company with a large debt is likely to be more volatile since the company’s income will be geared towards interest and debt repayment. By contrast, you may also look for companies which are generating massive returns with little debt or expenditures.
This financial analysis of the company should also tell you how well the company is placed to face adverse economic conditions. Stock markets and economies are not immune to storms. They have arrived in the past and they will come once again in the future too. There is no way to avoid these difficult economic situations. The best way to mitigate this risk is by investing in a company that can withstand these tumultuous times. Granted that the company’s growth may be a bit slow in this period, but in the long run, they are likely to come out stronger than the ones who were forced to seek a bailout.
The company is doing well in its sector
When you are investing in a company, you should always remember to compare its performance with its peers. This will give you a good idea of where the company stands in its sector and how well it is doing with respect to its peers. If you happen to find a company that is doing better than the one you are looking at, then it may be worth examining the other company. The other way to approach this is by looking at the individual sector and comparing the performance of top players.
You can also look at the P/E ratio of the company and compare it with the industry’s average. If this ratio is less than the average, then the company’s stock may be undervalued. By contrast, if the P/E ratio is greater the sector average, then it implies that the stock is heavily overvalued. However, remember that this should not be the sole factor you base your decision on. You can visit sites like Bankbazaar to help you judge the performance of a company better.
The company’s management is generous towards its shareholders
Ideally speaking, you want to invest your money in a company whose executives reward the shareholders with generous dividends and cleverly-executed buyback plans. In your research, you should look for the company’s dividend history and other parameters like the bonus, splits, and buybacks. After all, you want your money to be invested in a company that has your best interest at heart. If a company has been regular with its dividends, then it is a good sign.
There are many companies with excellent financial health but a poor record of dividends. Instead, they tapped into the money chest and used it for their own benefits. You are investing your money in these companies and it is only natural to expect some sort of appreciation and rewards for your investment.
The company has a dedicated customer base
Many people are quite picky when it comes to everyday stuff. For instance, you may have a favourite brand when it comes to chocolates, beverages, cigarettes, or even something as generic as a toothpaste. Over the years, this kind of loyalty has helped several companies grow their sales and expand their profit margins. They can increase their prices for a particular product or service and the customers will still pay those prices.
This surplus cash can be directed to boost brand loyalty with the help of marketing campaigns, innovations, and new products. This leads to an endless cycle whose end result is reflected in the company’s performance and, in turn, its stock. As an investor, you should definitely look for this factor.
As we mentioned in the beginning, there is no sure shot recipe for success in the stock markets. You can select your stocks with careful consideration and they still may go down owing to the volatile nature of the markets. Instead of panicking and selling your shares in such a situation, you should hold onto your position. Stock markets are cyclic in nature and if you are patient enough, your patience will be well-rewarded.