The stock markets are often compared to weather, sometimes breezy, sometimes stormy, and also bright on some days, but most unpredictable. Although analysts across the globe design various technical analysis techniques to predict the markets through patterns, it continues to remain a challenging area. Due to stock market volatility and unpredictability, many investors prefer to invest for the long term, aiming for returns through capital appreciation.
Warren Buffett, a legendary stock market investor, has often spoken about the benefits of investing for the long term to be safer from market highs and lows and to minimise risks.
An investor can use various ways of identifying good long-term stocks for investment. To aid the investment process and enhance the chances of profitability, here are some factors that long-term investors can consider.
Know the quality of company management
Investors must check the frequency with which the company may be raising fresh capital. Frequent capital requirements could also indicate a lack of competitive strength and lack of sufficient cash-flows for sustainable business. Many blue-chip companies like Asian Paints, Infosys, etc do not need to raise capital frequently. Investors must also have a look at the pay issued to company directors. If the salaries paid to company directors are significantly higher than those paid to their counterparts, investors must carefully assess their investment in the company.
Frequency of dividend
If a company is either having a lower dividend payout even after earning good profits or it is paying out dividend very frequently despite poor earnings, it should raise red flags for investors. Lower payouts should also reflect in higher capital utilisation. Investors must also check if higher dividend payouts have been funded by borrowings.
Financial strength
Some companies may be earning revenue and making profits year on year. However, this growth may not result in lowering of debt. This could signal the possibility of a lack of effective utilisation of working capital. Investors must therefore evaluate the company’s financial strength by looking at some of the important financial ratios before taking an investment decision.
Capital reinvestment
Investors must learn about the percentage returns that a company earns from its capital employed or what is its ROCE (return on capital employed) in a year. For long-term investment decisions, investors must know whether the company has been able to consistently earn the same levels of ROCE or lower. While consistent ROCE is difficult to achieve, if a business does so, it can be considered as a high-quality business.
Business risk
Any business is established to cater to a certain set of consumer demand, and business solutions are designed accordingly. However, demands can keep changing with time. This means, the business solutions too must change to align with changing demand.
For example, Tata Motors has launched its electric car segment to adapt to changing times and evolving demands. If Tata Motors would not have entered this space, competitors like Ashok Leyland, Mahindra, etc. would have enjoyed a larger market share.
Thus, business risk may always exist, but whether the business is capable of adapting to change and facing the risk is what investors must gauge.
Smart decisions vs. trending decisions
Any company can beat the competition only if stays ahead of it. This means the company must take business decisions that no other competitor has thought about instead of only replicating what other businesses do.
A classic case is of Vodafone, which failed to adapt to changing times, resulting in poor service quality. Another recent example is of Big Bazaar, which could not change its business model and suffered losses that further resulted in debt pile-up.
Investors must look out for the decision-making pattern of company promoters. Also, sometimes promoters may take aggressive business decisions to stay ahead of competition, but these may be entirely unrelated to the business and could prove costly in the long run.
Conclusion
Warren Buffett once said,
“The stock market is a device for transferring money from the impatient to the patient.”
Patience and long-term consistency are very rare in stock markets, but those who have it can enjoy great long-term returns. Small stock market corrections make many short-term or swing investors worry about the possible losses. However, those who invest for long-term always look out for quality stocks during market corrections and enhance their portfolios with the right stock picks. Investors can pick quality long-term stocks by employing the above-mentioned decision enhancers to ensure capital appreciation as per expectations.
FAQs
Long-term stock market investment can range anywhere between 3-5 years, with some investors even opting for the 7-10-year horizon for further capital appreciation.
Compounding refers to the reinvestment of accrued returns. The profits made on the principal investment if reinvested will further increase the principal amount in the long run. Thus, compounding aids maximisation of returns on investment.
Long-term stock market investors must consider their financial situation, investment goals, and risk preferences to ensure that liquidity is not hampered at any point.
Long-term investments generally carry a lower risk of capital loss as compared to short-term or medium-term investments. However, this depends on the stocks chosen and their long-term performance.
Many value investors look for small-call stocks with good fundamentals to benefit in the long run. However, value investing requires a detailed research and may carry higher risks.
