For those with a long investing horizon, learning to swim against the market tide now could result in massive gains later down the line. With this in mind, here’s a four-point checklist I’ll be using to at least narrow my search for the best stocks.
1. Balance sheet strength
There’s a reason why this criterion takes priority over all others. With all sorts of businesses likely to suffer over the next few months (possibly years), it’s those with poor balance sheets that are most vulnerable.
At times like these, Fools need to avoid companies with high operational and financial leverage. In other words, steer clear of those with big fixed costs (relative to their revenues) and those needing to raise capital through loans and other financing options. On the flip side, companies with no debt and loads of cash are ideal.
One way to get a handle on the financial robustness of a company is to call up the latest results from its website. This information might not be completely up to date but it’s as good a place as any to start.
2. Competitive advantage
Even if a company manages to make it through the coronavirus crisis, it’s unlikely to thrive in the future if it lacks some sort of competitive advantage or, as Warren Buffett call is, an ‘economic moat‘.
Moats can be wide or narrow. I’d recommend trying to find the former. Evidence of a wide economic moat is when rivals struggle to break down a company’s market share. For some, this will be ‘intangible assets’ such as strong brands. For others, it will be innovative technology, or cheap access to raw materials.
A narrow moat, by contrast, is one that only protects a business for a relatively short period of time because the barriers to entering its market are low.
3. Proven management
Knowing the companies I’m a part-owner of are led by prudent management teams gives me confidence that they stand a better chance than most of weathering the economic storm we face. For this reason, I think it’s important to check the track records of those in charge before investing.
The only thing better than highly competent management is highly competent management owning a decent slug of shares. Having their own wealth invested in the business should ensure their interests are aligned with the rest of us.
While significant ownership is often the case with smaller companies, it’s less common with established stock market juggernauts. For this reason, I wouldn’t automatically dismiss investing in market minnows at the current time.
4. Reasonable price
You may think that nabbing a bargain is the most important factor to consider, particularly during the crisis in which we find ourselves. Since there are many companies out there trading on temptingly-low valuations that may actually struggle to survive, however, I respectfully disagree. Stock pickers need to be more selective than ever.
Like most things in life, you get what you pay for. As fund manager Terry Smith of Fundsmith regularly remarks, it’s what businesses actually do over many years that really matters, not the brilliance of your timing. Those that grow and reinvest their earnings at a high rate of return will be the ones to thrive.
Don’t compromise quality for price.
