6 Key Signs a Stock Is a Good Long-Term Investment
Written by
John Csiszar
Edited by
Gary Dudak
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Over the long run, the stock market in general has proven to be a solid investment. Although bear markets are inevitable, the market has always gone on to make new highs, and it has never lost money over any 20-year rolling period.
Learn: How To Invest in GoldKnow: 3 Things You Must Do When Your Savings Reach $50,000
But individual stocks are not like the stock market as a whole. Stocks can fall for extended periods of time, even when the market as a whole is rising, and sometimes they never recover. So it’s essential if you’re going to invest in individual stocks that you understand the characteristics of ones that will be good long-term investments. Here are some of the hallmarks.
Consistent Growth
If you’re looking for a good long-term investment, you’ll want to pick stocks that have a good track record of consistent earnings growth. The more a company can show that it can perform well even in slower economic times, the more likely it will be a good long-term investment.
Stocks that double in price overnight but don’t have any earnings to back up those price gains typically fizzle out in short fashion. Long-term winners show consistent earnings growth that investors can rely on, supporting their prices over years or even decades.
High Return on Equity
While a number of different factors can move the price of a stock over the short run, profits are what drive long-term gains. A company that can earn a high return on equity demonstrates that it doesn’t need additional money flowing in from equity investors or debt sales in order to generate profits.
This characteristic is so important that some investment companies, such as Jensen Investment Management, use it as the first step of their investment management process. According to Jensen, the universe of companies with a high ROE “produces companies with sustainable competitive advantages, strong growth potential and stocks with a lower beta relative to broad market indices.”
Low Debt Levels
Just as a high level of consumer debt can stall a household’s personal financial growth, so too can high levels of corporate debt prevent a company from generating consistent returns. In poor economic times, companies that are highly leveraged with a large amount of debt might find their finances strangled, as debt service payments exceed the amount of revenue they’re generating. Companies with low levels of debt, on the other hand, can hunker down and wait out any economic storms.
While it’s true that highly leveraged companies can generate outsized gains when times are good, this type of “boom or bust” approach isn’t usually the key to consistent long-term profits.
Solid Management
Even a company that offers a good product or service that everyone wants might not always be profitable, or as profitable as it should be. It still takes a good management team to be able to deliver the type of quarterly earnings and consistent growth that makes investors take notice. Good management teams can even turn underperforming companies into Wall Street darlings.
Rising Dividends
Companies that pay consistent and rising dividends are, by definition, cash flow machines. As revenues increase, so too does the ability of a company to pay a rising dividend to investors.
Typically, these so-called “dividend aristocrats” — those that pay increasing dividends for decades in a row — are mature companies that are dominant in their industries. While they may not be as exciting as small-cap stocks that can pop 50% or 100% seemingly overnight, the stability of their businesses usually translates to steady long-term gains.
A Portfolio of In-Demand Products
Although a stock can make big gains on the back of a single successful idea, those that provide decades of positive returns typically have a myriad of in-demand products. Multi-brand companies tend to have more consistent earnings reports, as deficiencies in one area are often made up for by gains in others. This in turn usually translates to less volatile stock prices and more predictable long-term gains.
The Bottom Line
Stock prices move up and down based on a number of factors. Although the characteristics above are a great place to start when researching stocks, you’ll have to dig a little deeper before you can choose which ones are the best investments for you.
For example, some stocks are more volatile than others, and if you have a weak stomach when it comes to seeing losses, they might not be appropriate for you, even if they show great potential for future growth. Others may be reaching the end of their profitability cycle, so it’s important to dig deeper into how exactly a company is generating its profits and whether or not that’s likely to continue. Still others may find themselves trading more on emotion than on fundamentals, something that’s beyond your control but that might prevent you from earning the profits you think you should.
For these and so many more reasons, it’s usually a good idea to build a portfolio of stocks rather than to bet your whole nest egg on the fortunes of a single company.
