How to Pick Stocks for the Long Term

Investing can be daunting for many; there are so many different routes you can take regarding your investing strategy and what stocks you decide to invest in. You may be interested in becoming a long-term investor, but how do you know which stocks are best for your long-term objectives?

When learning how to pick stocks for long term, you must look at several factors, including your goals, common stock indicators, overall discipline, and risk management. This will help you invest for the future and achieve your goals.

What Are Long-Term Stocks

Long-term stocks are investments that are held for one year or more. Investors in long-term stocks typically look for higher rates of return over time or a steady dividend yield.

When buying long-term growth stocks, it is essential to understand that it is a much more aggressive strategy than buying stock indexes or mutual funds. It is important to pick companies with solid financials for these reasons. As a long-term investor, one must be willing to hold stocks for an extended period.

Warren Buffet said, “If you aren’t willing to hold a stock for ten years, don’t even look at it for ten minutes.”

Determine Your Investing Goals

Are you genuinely looking to become a long-term investor? Are you willing to hold on to a single stock for ten years or more? Are you interested in dividends, or are you looking to live off of your money for retirement?

These are essential questions to ask yourself before purchasing your first long-term investment. Remember that investing in individual stocks can be relatively aggressive. A willingness to allocate funds to other forms of investing is needed if you do not want your whole portfolio to be a group of 5 or 6 stocks.

Older investors tend to want to preserve their capital as they near retirement, while other investors are more interested in generating income in the form of dividends and distributions.

Sit down and write your goals; how do you want to use your portfolio?

These goals will dictate your future investments and how you search for new companies.

Focus On The Fundamentals

Many investors align with either growth or value investing strategies.

Growth Investors: Focus on growth in the future and are much more interested in the potential of any given company.

Value Investors: Are rooted in the present. They look at current stock prices and the financial standings of their prospective companies.

Other Investors: Are interested in dividend yield, especially if they want to generate income in that form.

Research

When researching new investment opportunities, the process must be kept simple. Looking into growing markets like the technology industry and Global Tourism (According to IBIS world Global Tourism is one of the fastest-growing industries in 2023) are great ways to start your search.

Picking stocks that have been around forever, such as Coca-Cola (NYSE: KO) or Costco (NASDAQ: COST), is also a well-grounded action plan.

How to pick stocks for long-term

Once you’ve created a robust list of great companies, narrow it down to the best companies for YOU.

To do this, you must evaluate your day to day life. Does this company play a role in your present life? Do you use their product? Do you support what they are doing in the world?

Say you were looking to invest in AAPL (Apple Inc). Do you use an iPhone or MacBook every day? Will you continue using these products well into the future? Would other people benefit from using Apple products in the same manner that you do?

You might have found a good stock if you answered yes to all of these.

Knowing that you use the products of any given company will make it much easier to hold their stock when it dips. The whole point of long-term investing is to hold onto your assets for an extended period, and if you sell the moment the price drops, then you do not believe in them.

The importance of the board

While it is essential to choose a particular company that you use on a day-to-day basis, it is also valuable to align your values with those running it. Looking into the board of directors will give critical insights into who oversees company operations and their business philosophy.

If you care about ethical business conduct, find good companies run by virtuous people.

If you do not agree with the fundamental choices of the people who manage the day-to-day business operations of a company you are researching, how can you agree with the choices they make for said company in the future?

Use resources such as interviews and press releases to research the board of directors.

Market Cap

Market Capitalization, commonly referred to as “market cap,” is the measure of a company’s size. It is calculated by multiplying a company’s shares by its current price.

There are three main types of market cap:

Large-Cap

Large-cap companies have a market capitalization of $10 billion or more. Generally, companies with higher market caps, like Large-cap stocks, are more established and less volatile than their counterparts.

Mid-Cap

Mid-cap companies range from $2 billion to $10 billion. These companies are usually more established than small-cap companies and may also be less prone to drastic changes in stock prices.

Small-Cap

Small-cap stocks have a market capitalization of less than $2 billion. They may be considered riskier due to their lack of history or financial track record.

Evaluating risk

Typically newer companies are considered “riskier” for long-term investors; however, if one is focused on growth, this may be something that will be overlooked during valuations.

When the financials are solid, but knowing how the company is run eludes you, it is always better to look elsewhere.

This is why finding companies you understand and use daily is crucial. The better your knowledge of any given company or industry, the less risk you take.

If you do not have tolerance for the risk you take, you’ll surely lose money. Emotions can be easily swayed by a slight dip in stock price or an unfavorable news article that paints the investment in a bad light.

Diversify

Looking into different industries will diversify your holdings and offset losses due to problems within a given industry.

Some sectors you could look into include technology, construction, health care, production, and education.

Spreading investments across different asset classes like stocks, bonds, and cryptocurrency will also help to diversify a portfolio.

What is a Competitive Advantage?

There will always be competition between companies making similar products. What separates good companies from great ones is a competitive advantage.

Let’s take a look at Apple; what is their competitive advantage? Essentially, they are a closed system. The Apple iPhone connects to all other apple devices. For the consumer, this is amazing because they can interact with their various products seamlessly.

If a consumer ever wanted to change to a different company, like Samsung, it would be complicated to switch over since all of their data and projects are stored between their Apple products. This keeps them using apple products and only apple products well into the future.

Analyze Economic Indicators

Using various resources to aid in technical analysis is optimal for long-term investors.

Some of these resources include:

• SEC Filings
• Quarterly Reports
• Interviews
• Press Releases
• News articles
• Financial statements

Websites such as macro trends or yahoo finance are great for quick access to financial data that can be found on SEC filings such as the 10k report.

The importance of historical data

Younger companies are considered riskier because there is not enough historical data that shows how the company could perform in the future. Typically, buying stocks that are ten years or older is a safe bet.

Take Canadian Tire (CTC-A.TO), for example. They have been around for a little over 100 years, and their current market value is around $161 a share with a market cap of $9.76B. A mature company as old as Canadian Tire is very likely to stick around and should be easy to research in terms of how they’ve grown in the past and how they will develop in the future.

Now, look at Tencent Music (NYSE: TME). They are a young company that has only been around for a limited time (since 2017); however, their parent company, Tencent (TCEHY), is much older. They are a large-cap of $14.70B and are trading at a current stock price of around $8 per share. A quick look at their earnings per share and income data shows the company is growing at a high rate. Their P/E ratio of 31.25 means that investors expect a high growth rate for the company.

To the growth investor, this may be a good investment to look into. A value investor might not research further after seeing that the TME is close to 10 years old.

Look For Earnings Growth

Earnings per share are calculated by dividing a company’s net income by its common shares outstanding. It is used to indicate how much money a company makes over each share of its stock.

According to Forbes, when past earnings per share have a solid growth rate of 8% or more in the last five years, it is a good indicator that the company will continue to grow.

Always check that earnings growth is consistent over the past 5 or 10 years. You can also check the trailing earnings per share on websites such as yahoo finance.

Look For Sales Growth

Revenue is the number of sales a company makes over a designated period. Looking into revenue per share or sales per share can provide a quick understanding of a company’s productivity.

Comparing a company’s revenue per share or RVPS growth to that of its competitors will indicate how it’s performing over different periods and whether or not that performance is substantial.

Cash Flows

Operating Cash Flow (OCF) is a measurement that indicates whether or not a company can generate positive income to support its growing business.

Free Cash Flow (FCF) is cash that is generated from regular day-to-day business after subtracting capital expenditures.

Using OCF and FCF will tell you if a company generates enough cash to pay its expenses (OCF) and has enough money to buy back shares or pay dividends (FCF).

Debt

High levels of debt can be detrimental to long-term investors. Avoiding debt altogether is a good rule of thumb; however, there are only a few companies out there have zero debt.

Typically, if a company can pay off its debt within three years, then it would still be reasonable to look at it. In uncertain economic times, high amounts of debt can leave a company bankrupt and its investors out of luck.

Average Daily Trading Volume

The ADTV indicates how many shares of stock are traded each day.

When ADTV increases or decreases rapidly, it shows a shift in what people think of the asset in question.

According to Forbes, a higher daily trading volume of 1 million shares suggests that a company is quite liquid and has significant public interest.

Price drops

Use stock charts to see how a company has behaved in the past. There is always a reason why significant dips in a stock’s price occur. Diving into news articles and press releases from the time of a drop will help you understand why these things happen.

If a stock that you already own dips for similar reasons that it has in the past, it’s easier to hold onto it instead of panic selling because you don’t understand the company’s history

Find your Price

Using various methods to choose from, find a price for the intrinsic value of the stock you are looking at.

Some of these methods include looking into the price-to-earnings ratio or creating a discounted cash flow analysis.

Discounted Cash Flow Analysis

Models such as a discounted cash flow analysis can help find a company’s intrinsic value.

It considers the expected growth of earnings and future cash flows and discounts them at an appropriate rate over a given amount of time.

In the case of long-term investing, the amount of time would be 10 years or more. The resulting number can help determine whether a security is overvalued or undervalued.

Examine The P/E Ratio

The price-to-earnings ratio is calculated by dividing a company’s current market price by its earnings or income per share. It is used to decide whether or not a company is trading above or below its value.

If the P/E ratio of a given company is lower than other companies in its industry, it may be a good indicator that the stock is undervalued.

Margin Of Safety

After determining a fair price for your stock, discounting it at a reasonable rate for your risk tolerance will give you a margin of safety below what would be considered a “fair price.”

If your valuation is wrong, a margin of safety will prevent significant losses in your investment portfolio.

Benjamin Graham, the father of value investing, introduced the concept of Margin of safety as the difference between a stock’s intrinsic value and its current market price.

Investors such as Warren Buffet have been known to discount 50% of a stock’s intrinsic value for his price target.

The Motley Fool suggests that 15%-30% is a reasonable margin of safety for long-term investors who are confident in their valuation.

Pick a strategy and stick with it.

Avoid making emotional purchases, and ensure you have a reliable method for analyzing current and future stock purchases. Creating a logical plan based on valuations and sticking to it is the best method for the long-term investor.

Choose companies that fit your comfort zone and avoid frantically buying because everybody is telling you about it.

Do your due diligence and research companies that fit in your circle of knowledge. Vet the owners of new companies and decide whether or not their values align with yours.

Look into the financials through SEC filings, quarterly reports, or websites like yahoo finance and macro trends to aid in your technical analysis.

Use your findings to buy the stock within a margin of safety and hold onto it for at least ten years. Stocks tend to dip over time, so it is important to focus on the financial data and use your knowledge of the company and your risk tolerance to make reasonable decisions regarding when you want to buy or sell a company.

Following the methods above to build a diversified portfolio will help you find success in the stock market.  By using these strategies and continuing to develop your method of technical analysis, you will learn more about different industries and expand your horizons to new heights.