“If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.” – Warren Buffett
According to Warren Buffett the best holding period is forever. Don’t buy a company if you don’t plan on holding it for many decades to come.
The stock market is currently overvalued. I have heard speculation of a stock market crash heading our way. People typically tend to react negatively to this type of news. The majority will fall into a panicked state, contemplating an exit strategy, but not me. I'm not even batting an eye at stock market crash predictions. I have a long-term horizon, invest in only the best and hold stocks for as long as possible.
Market crashes are predominantly seen as a major catastrophe, causing investors to head for the hills. I prefer taking the contrarian approach. To be frank, I’m quite excited about it. I find it exhilarating, because I am sure a stock market crash will deliver sound, significantly undervalued stock-buying opportunities worth holding forever or until I reach my target exit point.
If the market crashes we will have our pick of the litter, but how do we know which stocks are the best to pick?
When you do not have an intelligent stock picking tool to guide you through sound investment opportunities, you need to do extensive homework. Compare data sheets, financial reports and statements to find the cream of the crop.
If you want to buy stocks that are worth holding forever you should ask yourself the following questions when picking your stocks:
1. What does the company do?
It is essential to know what the company does. One of Warren Buffet’s top rules for picking stocks, is that you need to understand the business and the industry in which it functions. He doesn’t understand the tech industry so he doesn’t invest in it. It is as simple as that. Take it from the world’s most successful investor.
2. What is the company’s earnings history and outlook?
Is the company profitable? Has the company been making money and will it continue to do so or are earnings volatile? It is vital to invest in companies that will keep growing over the long term. No use in investing in a company that is heading for bankruptcy.
You can find the answers to this question by looking at a company’s quarterly and annual reports. Focus on the overall trend of the earnings rather than focusing on a single quarter.
3. What is the fair value or intrinsic value of the company’s stocks?
A company’s fair value, more commonly referred to as intrinsic value, can be determined by applying the process of fundamental analysis. You can valuate a company by using some of the following metrics: price-to-earnings, debt-to-equity, price-to-book and return on equity to name a few.
4. Does the company have an economic moat?
Who is the company’s competition and does the company have an advantage that sets it apart from the rest? Businesses all compete to be the best. It is worth identifying a business who is the best at what they do. The most important thought to ponder about is whether the company will be able to stay ahead of its competition or not. A company need to spend enough funds towards research and development to stay in one of the top positions.
5. Does the company pay dividends?
Dividends are usually a sign that a company is in good health. Receiving regular dividends are wonderful, but it shouldn’t be the sole reason for choosing a stock, because it isn’t permanent. If a business is struggling they may cut their dividends. It can be a great source of regular income, but only if the business stays profitable. If a company pays its dividends using debt, you shouldn’t buy its equities.
6. Does the company have positive free cash flow?
The amount of cash available in a company shows you its potential to generate profit. Having free cash flow (CFC) is important because it allows a company to pursue opportunities that enhances shareholder value. Dividends are also paid from FCF. If the business doesn’t have FCF they cannot afford to pay dividends. If a company uses debt to do so, it is facing a financial crisis.
7. How much debt does the company have?
If a company’s debt outweighs its profits, you should take it as a clear warning sign. The higher the debt, the higher the amount of risk for shareholders. Financing growth with debt is not a sustainable practice. It can lead to volatile earnings, high interest rates or bankruptcy. For instance, Buffett only invests in companies with debt-to-equity ratios below one.
8. Does the company show growth potential?
A good investment should show a growth trend over the long term. A sound company will spend a lot of its money on research and development to keep the company profitable and ahead of its competitors.
9. Who runs the company?
Knowing who runs a company is very important. The only way to find this out is by doing the necessary homework. The management team has the power to make a company wonderful, but at the same time they can destroy a company. If you are going to invest in a company, make sure the people running it knows what they are doing and what they should be doing to keep the business profitable in the future. To refer back to the point of understanding the company, Buffett once said that he only invest in companies that can be run by fools, because sooner or later the company will be run by one. Buffer your portfolio against fools by picking great stocks.
Do not overcomplicate your investment decisions. Use all of these questions in conjunction with each other and you will be picking stocks worth holding forever. Never stop asking questions and never stop searching for the answers.
This is a short list that covers the most critical questions, and there are still a multitude of question that you can ask yourself before picking stocks. Which questions would you add to the list?