Long-term investors in the stock market look for great companies and buy the stock at a great price. With this formula your chances for long-term investing success are much higher.
Successful long-term investors find great companies and they buy the stock at a great price and hold it as long as the great company remains great.
The search for great stock is really to search for a great company. Great companies focus on the long-term and creating wealth for their owners.
Where you find great companies? Great companies can be found in every sector of the economy.
Some of them are household names and appear in prominent stock indexes such as the Dow. Others are not quite so well known but are still leaders in their particular industries.
You can identify great companies by several attributes. The most important attribute is they are leaders in their particular industries and probably have been for many years.
Not all great companies are decade old but many have survived economic cycles that crippled weaker companies. This is one of the reasons it is helpful to look at companies that have been around for quite a while and have prospered in good markets and held their own when times were bad.
When a company has been a leader in its industry for many years, it is often established products or services that have held off competitors and prospered by the competition.
However, just because a company has been around for many years and is large doesn't mean they are immune to competition.
Many years ago Sears was a dominant retailer in the consumer market. Virtually any shopping mall of size had a large Sears store. One of his main competitors Montgomery Ward could also be found in shopping malls across the country.
However neither of these retailers adopted adapted to changing consumer markets and/or and are mere shells of their former selves. Montgomery Ward exists as an online seller after bankruptcy and several different owners of the brand.
This brings us to the second important attribute of a great company. Great companies surround themselves with a wide economic moat.
An economic moat is a strong competitive position that makes it difficult for competitors to capture much of their market share.
Microsoft is an example of a company with a large economic moat. Its operating system is installed on well over 80% of the personal computers in use. Its office suite is likewise dominant in this market.
Because of this huge base, Microsoft can generate tremendous profits from those business lines. However, technology is moving towards a mobile base and of Microsoft is unable to adapt or compete it may suffer the same fate as Sears.
Another important attribute of great companies is that many pay dividends on a regular basis and have done so for many years.
Dividends provide investors with current income, which is why many people hold these stocks in a qualified retirement plan such as an IRA or 401(k).
This way they defer income tax on the dividends until they begin make making with withdrawals at retirement.
A number of companies have dividend reinvestment programs, which allow your dividends to accumulate and buy additional shares of the stock directly from the company.
For many long-term investors, this is a way to earn additional shares without any additional out-of-pocket money. However, you can also use the dividends for other purposes.
For retirees, dividends provide a reliable source of income.
Many great companies do not see significant growth in their share price in part because major institutional investors tend to hold the stock and not actively trade it.
Over time the stock will appreciate thanks to continued solid earnings and dividends, however is not realistic to expect huge growth in capital gains.
How do you identify a great price for a great stock? The next article in this series will answer that question.