Today, I’m going to share with you how to pick the right stock.
1. Stick with what you understand.
It is simple, but it’s also one of the most important.
Every time I hear someone talking about latest tech or biomedicine or even EV stocks, the story sounds great. But the problem is that I do not understand in nanomedicine or technology. Neither is the person talking about the stock.
Look, if you can’t explain the business model of the company or how the company makes money to a 10-year-old, then why in the world would you invest in its stock?
The more you understand the company’s products, its competitors, and even its weaknesses… the better you’ll be able to predict future cash flows.
Starbucks (SBUX), for example. Every time you go to buy coffee, you may notice how many people are standing in the line waiting for their cup of coffee, and if you see this consistently you have to feel good about their stock.
It’s simple, but it works. Starbucks model isn’t a secret. The more coffee it sells, the more its stock price should go up. And there are plenty of businesses you likely know and can keep tabs on.
For example, how often do you shop on Amazon (AMZN)? Do you have a PayPal (PYPL) account, how many times you use it more recently?
Stick with companies you know and understand. By just doing this, you’ll become a better investor overnight.
2. Find a company with a durable competitive advantage
Since you are looking for stocks to hold for a decade or more, You want to be sure the company is going to be around and thriving 10, 15, and even 20 years from now.
In other words, you need to find what is called “forever business”
you need to find companies that have strong advantages over their competition. They need to have what Warren Buffett would call a “moat.”
This can come in the form of a powerful brand, a lock on distribution, a large customer base, or ways to retain its customers.
For example, Coca Cola, has a moat because of how massive it is.
This is a company that will stand the test of time. It’s a stock you can sleep well at night owning.
3. Look for Dividend paying stocks
As a long-term minded investor, you need to look for dividend paying stocks.
To find the most consistent dividend payers, just google: List of Dividend Aristocrats. These are S&P 500 Index companies that have increased their dividends for 25 consecutive years or more.
Without knowing anything else about the company, you know a Dividend Aristocrat is a high-quality business. There’s no way a company could increase its dividend for 25 consecutive years without generating a lot of free cash.
If you want long-term success in the market, own high-quality dividend payers.
4. Own companies that are highly efficient.
You want to buy companies that don’t have to spend a lot of money to make a lot of money.
These are companies that are highly profitable and can return money back to shareholders. One way to find these efficient companies is by looking at something called return on assets.
It is equal to net income divided by total assets. The higher that number, the better a company’s management team is at using its assets to generate income. I like seeing a company that has an ROA of at least 10%.
5. Be aware of the valuation … do not focus on it.
As an investor, you always have to think about valuation. If the best business in the world is trading at an insanely high price, it can still make for a bad investment. Take, for instance, the famous example of Microsoft (MSFT). If you bought it at the height of the dot-com boom, it would have taken over a decade for the stock to just break even.
Stick with reasonable prices. You don’t want to be in a position where you’re paying 60 times earnings or 20 times sales for a stock, even a great one. Do the valuation, but do not focus on it.