5 Metrics to Help You Find the Best 'Forever Stocks'
We live in an age of instant gratification. Patience has become a lost virtue, especially with the advent of the smartphone and personal computer. And nowhere is this truer than in the stock market, with investors jumping from one idea to the next in an attempt to catch the next hot stock or investing theme. This rapid-fire trading ends up costing many investors more in commission and fees than is actually earned in the investment.
Unfortunately, many brokers encourage this type of hyperactive investing, as it fills their coffers with coveted commission dollars. But while this type of hot-hand chasing investing can work for savvy and nimble traders, it is far from an ideal tactic for most investors.
History has proven investors are generally much better off by investing in fundamentally solid stocks, and using the forgotten virtues of patience and discipline to grow their portfolio organically. These are what we here at StreetAuthority call "Forever Stocks." In fact, Street Authority co-founder Paul Tracy has built a very successful portfolio using this strategy. Paul only chooses stocks so that no matter what happens in the economy or the stock market -- short of absolute Armageddon -- you could feel reasonably safe about owning during the long-term.
The problem is this buy-and-hold strategy is out of style. Many believe it's old and no longer relevant to today's fast-paced, computer-driven environment. Well, these detractors couldn't be more wrong. Buying and holding a stock for the long run takes advantage of the inherent upward drift of the stock market and the improving economy. It also benefits from the ultra-low interest rates and fiscal stimulus from central banks.
However, you just can't go buying every stock expecting the Forever Stock strategy will work. Here are several fundamental metrics that can help you select the best Forever Stocks...
|Cash flow and debt
Cash flow is the amount of money going in and out of a business. Debt is the total amount of money owed by a company. A company's debt obligations must be manageable in relation to its cash flow for it to be a good forever stock candidate.
|Price-to-earnings (P/E) ratio
This ratio is determined by dividing the price of the stock by what the company earns per share. This ratio is a relative metric, so it's designed to be compared to other companies in the same sector. A high relative P/E ratio indicates that investors are paying a higher price for every dollar of earnings. This means the stock may be overvalued. By the same logic, a low P/E ratio points to an undervalued stock.
This is my personal favorite fundamental metric. It is used to discover whether a stock is over or underpriced. Book value reveals what a company would be worth should it be liquidated today. Determining the ratio between a stock's price to its book value is easy. Take the current price of the stock and divide it by the current quarter's book value per share. If your stock is selling at a price above its book value, then it is generally considered to be overpriced. If it is selling below book value, then it is considered to be underpriced. Book value should be used as a relative measure to compare stocks within the same industry/sector and is most wisely used in conjunction with the other metrics.
This is a major theme of the forever stocks strategy. Companies that have a history of increasing dividends not only are enriching investors, but they are signaling long-term strength and management confidence.
This is often another signal of internal strength of a company. Buybacks are used to increase share value by reducing supply or to battle unwanted takeover attempts.
Risks to Consider: A company can have positive rankings in all five of the above metrics yet still be a poor investment. These metrics simply place the odds of a successful buy-and-hold investment in your favor. Unfortunately, there are many factors that are out of our control as investors. For this reason, be certain to always use stops and position size based on your risk tolerance and goals
Action to Take --> Buying and holding stocks for the long term is a wise investment strategy. It saves on broker commissions and takes advantage of many of the inherent features of the stock market. Simply put, these are the stocks you can buy, hold, profit from and basically forget about, without losing sleep at night. The five metrics listed above can help weed the good buy-and-hold candidates from the questionable ones.
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StreetAuthority LLC does not hold positions in any securities mentioned in this article.