Most investors have heard and read about Warren Buffett and his successful strategy of investing for the long term. And most also know how unnerving it gets when your holdings drop in value even as you patiently look to the horizon. Therefore, no matter how rewarding it may ultimately turn out to be, this game is not for everyone.
But just suppose you were one of these patient folks: how should you go about doing this? What are the basic steps to follow or things to keep in mind?
First, do your research. This includes looking at the company's financial statements, reading analyst reports and following news about the company. The goal is to have a clear understanding about the company's business model, industry position, financial performance, competitive advantages and growth prospects.
Second, evaluate the financial health. Examine the company's financial statements, checking for things like revenue growth, profitability, debt levels and cash flow. Look for consistent revenue and earnings growth, a healthy balance sheet and strong cash flow generation.
Third, consider industry trends. Analyze the industry's growth potential, competitive landscape and any potential risks or challenges. Look for industries with favorable long-term prospects and companies that are well-positioned within those industries.
Fourth, assess the stock's valuation relative to its intrinsic value. You could use valuation metrics like price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, or discounted cash flow (DCF) analysis. Look for stocks that are trading at a reasonable or discounted valuation compared to their potential.
Fifth, diversify. The importance of a diverse portfolio can't be overstressed. Your portfolio should be balanced across growth profiles and risk profiles; between steady, mature industries and fast growing industries. Diversification helps mitigate the impact of any individual stock's performance on your overall portfolio.
Sixth, rebalance your portfolio. Just because you’re holding stocks for the long term doesn’t mean that you stop monitoring and reviewing. You must make adjustments when things play out differently from what you were expecting. Also, you may need to sell a few stocks for your cash needs and compensate with other purchases. It’s important to follow closely all developments related to the stocks you’re holding. Rebalancing your portfolio helps you stay in touch with your long-term investment objectives.
Finally, don't panic-sell. The stock market is volatile and there will be times when the market takes a downturn. It's important to stay calm. If you sell your stocks when the market is down, you're likely to lock in your losses. Patience pays, as long as the long-term investment story remains.
Here’s a quick formula to evaluate long-term holdings:
Using the Zacks stock ranking system, identify #1 (Strong Buy) rated stocks. Check their performance over the last few years. Ideally, you should be looking at revenue growth, profitability and cash flow. But a good average earnings growth rate (say at least 10%) could serve as a proxy. Add to this the analyst- expected growth rate for the next 3-5 years (if the growth rate is at least same as in the last 3-5 years, it’s an indication of steady growth for a prolonged period of time). So we can keep this too at a minimum of 10%. If such a company also pays a dividend, all the better.
One stock that passes all these tests is
Graco Inc. ( GGG Quick Quote GGG - Free Report) . This provider of equipment and systems used to measure, move, control, spray and dispense fluid and powder materials supplies industrial manufacturers.
The reason it looks so good now is that it has a five-year historical record of 10.6% earnings growth. Analysts expect the company to grow its earnings by 10% on average in the next 3-5 years, And in the current year, it is expected to grow 16.2%. It also pays a small dividend that yields 1.23%.
Another stock on this list is
Lifetime Brands, Inc. ( LCUT Quick Quote LCUT - Free Report) , which is known for its kitchenware, tableware and other household products.
The company has seen earnings growth of 54.9% in the last five years and is expected to grow at 14.0% over the next five years. This year alone it will grow 93.6%. To top it all, its dividend yields a very decent 3.47%.
American International Group, Inc. ( AIG Quick Quote AIG - Free Report) , which offers insurance products for commercial, institutional and individual customers primarily in North America, has grown 30.5% in the last five years and is expected to grow 10.0% in the next five. It is currently expected to grow 44.6% this year. Its dividend yields 2.42%.
All of these stocks carry a Zacks #1 rank, indicating upside potential even in the near term.
Year-to-Date Price Performance Image Source: Zacks Investment Research