The key to successful long-term investing in stocks is simple: buy great companies at great prices and hold them while they make you rich.
After all, it worked for Warren Buffett and it can work for you.
But, you protest, Warren Buffett has dozens of very smart people working for him. True, but that's not how he started out. He made a fortune, before he had a staff of experts at his command and, I might add, before there were computer programs that crunched the numbers.
You may not be able to duplicate Mr. Buffett's native intelligence and foresightedness, but you can use his basic model for building wealth over the long term.
There are three basic parts to this plan:
Simple enough if you can identify great companies and you know what a great price is and you know how long to hold before selling.
One of the key features of great companies is their ability to hold on to a competitive advantage. This competitive advantage is often called an economic moat and it simply means the company is much stronger than its competitors. Great companies build this moat or advantage in many ways.
For example, innovative technology can be a competitive advantage, although not a great one - technology famously becomes obsolete or duplicated by competitors.
Size can be a competitive advantage. Wal-Mart, the world's largest retailer, can command exceptional deals from its suppliers that competitors can't match. In addition, the company has a super-efficient supply chain that helps keep expenses low.
Some companies rely on laws, rules or regulations to protect their competitive advantage. For example, pharmaceutical companies rely on patents to give them exclusive rights to new prescription drugs. Depending on the circumstances, the patent may give the company exclusive rights for 10 years or more, before generic drug makers bring out lower-priced versions of the same drug. However, during the exclusive period, the company can make a lot of money if the drug is popular.
Great companies are marked by a history of strong and growing earnings, revenue and other key indicators. Investors can use stock screeners to help cull though the many possible candidates to find the most likely prospects. If you are not familiar with stock screeners, you are missing out on one of the best and most essential tools successful investors use.
Great companies also have great managers. There are many ways to assess the quality of a company's management. Return on investment (ROI) is one indicator, although it has flaws. ROI in its simplest form measures how well the company manages the assets of the company.
Given a $100 worth of assets, a good manager might generate $8 in profits for the owners (stockholders), while another manager with the same assets may only return $2 in profits (or losses). Note, it is extremely important that you use ROI to compare companies in the same industry to have a valid comparison.
Another way to learn about management is by reviewing the documents regularly filed with the Securities and Exchange Commission. Documents such as the 10K and 10Q provide news and information on the key management staff. You can find resumes detailing experience and education. You can also discover if any of the key managers are in trouble with the law or regulators.
Information services such as Morningstar and others also provide information on managers.
These are a few of the ways you find great companies. Next, I'll look at buying at a great price and long-term holding.
After all, it worked for Warren Buffett and it can work for you.
But, you protest, Warren Buffett has dozens of very smart people working for him. True, but that's not how he started out. He made a fortune, before he had a staff of experts at his command and, I might add, before there were computer programs that crunched the numbers.
You may not be able to duplicate Mr. Buffett's native intelligence and foresightedness, but you can use his basic model for building wealth over the long term.
There are three basic parts to this plan:
- Buy great companies
- Buy at a great price
- Hold as long as the company is making you wealthy
Simple enough if you can identify great companies and you know what a great price is and you know how long to hold before selling.
Great Companies
There are a number of great companies and many of them don't make regular headlines like Apple or Google. You can find great companies in almost any industrial sector if you know what to look for. How would you define a great company?One of the key features of great companies is their ability to hold on to a competitive advantage. This competitive advantage is often called an economic moat and it simply means the company is much stronger than its competitors. Great companies build this moat or advantage in many ways.
For example, innovative technology can be a competitive advantage, although not a great one - technology famously becomes obsolete or duplicated by competitors.
Size can be a competitive advantage. Wal-Mart, the world's largest retailer, can command exceptional deals from its suppliers that competitors can't match. In addition, the company has a super-efficient supply chain that helps keep expenses low.
Some companies rely on laws, rules or regulations to protect their competitive advantage. For example, pharmaceutical companies rely on patents to give them exclusive rights to new prescription drugs. Depending on the circumstances, the patent may give the company exclusive rights for 10 years or more, before generic drug makers bring out lower-priced versions of the same drug. However, during the exclusive period, the company can make a lot of money if the drug is popular.
Great companies are marked by a history of strong and growing earnings, revenue and other key indicators. Investors can use stock screeners to help cull though the many possible candidates to find the most likely prospects. If you are not familiar with stock screeners, you are missing out on one of the best and most essential tools successful investors use.
Great companies also have great managers. There are many ways to assess the quality of a company's management. Return on investment (ROI) is one indicator, although it has flaws. ROI in its simplest form measures how well the company manages the assets of the company.
Given a $100 worth of assets, a good manager might generate $8 in profits for the owners (stockholders), while another manager with the same assets may only return $2 in profits (or losses). Note, it is extremely important that you use ROI to compare companies in the same industry to have a valid comparison.
Another way to learn about management is by reviewing the documents regularly filed with the Securities and Exchange Commission. Documents such as the 10K and 10Q provide news and information on the key management staff. You can find resumes detailing experience and education. You can also discover if any of the key managers are in trouble with the law or regulators.
Information services such as Morningstar and others also provide information on managers.
These are a few of the ways you find great companies. Next, I'll look at buying at a great price and long-term holding.
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