5 Signs That Indicate a Quality Stock

A company exhibiting all five of the attributes is likely to be a high-quality investment with significant potential for value generation.

Aug 23, 2014 at 8:00AM

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Every investor is looking to invest in quality companies. But how do you judge what makes a good company and what doesn't?

In addition to obvious signs of quality, such as increasing market share, revenues and earnings over long stretches of time, investors would also want to invest in companies that allow shareholders to participate in their growth and market success. Shareholder friendliness, therefore, is a another key characteristic a desirable company should exhibit.

The following list depicts five attributes that investors should look for in a company and they are indicators of potentially outstanding value generation in the future:

1. Increasing market share
If a company is successful with its value proposition in the marketplace, it will be able to push competitors aside and grab additional market share. An example for a company increasing its market presence over the last couple of years would be Apple and an example for a company losing market share would be BlackBerry.

The fight for market share is tough and usually fought by all means. Hence, companies that capture market share are doing something fundamentally right and usually report higher revenues and earnings, too.

Looking at a company's historical revenues and earnings is a great way of determining whether the company has been able to succeed in the marketplace on a consistent basis.

The financial statements of the company as well as the accompanying disclosures always include a description of the industry and the competition and provide investors with valuable insight.

2. Innovation
A company at the forefront of its industry needs to be highly innovative in order to stay competitive and defend itself against threats of new market entries and substitute products.

In other words: The company needs to be ahead of the curve and specifically ahead of its competitors.

Companies with long track records of innovation and performance are specifically desirable to invest in.

3. Low CEO turnover
Companies that are successful usually have strong leadership. In order to concentrate on the job, management teams must function under pressure and be able to adapt to changing industry conditions.

As such, a good sign that you are dealing with a great company is when management and CEO turnover is low. Sometimes, seasoned executives can stay in a leadership position at a company for many years if not decades.

Low CEO turnover, or management continuity, therefore is a strong signal you are dealing with a great business to invest in. High CEO turnover, on the other hand, points at serious issues at the company.

4. Shareholder remuneration
As indicated in the introduction, successful companies will allow their shareholders to participate in their success by offering a solid dividend yield and supplemental share repurchases to create value.

However, the company in question will also have to balance its remuneration policy with its need to make investments in order to sustain growth.

5. Reinvestment opportunities
Companies that retain profits are not necessarily shareholder unfriendly. If the company decides to retain earnings because it sees profitable reinvestment opportunities, this is clearly in the interest of the shareholders who should see the value of their company ultimately increase.

Warren Buffett's investment holding Berkshire Hathaway is a great example of a company that doesn't pay a dividend and reinvests all of its earnings. Reinvesting is absolutely essential and the one of the reasons why Buffett is among the richest men on Earth.

The Foolish bottom line
Successful companies can quickly be identified by examining their past revenue and earnings records and by determining whether the company has produced innovative products or disruptive new service offerings.

Moreover, investors should clearly pay attention to a company's shareholder remuneration policy and how it balances the need between shareholder compensation and reinvestment.

If the company also convinces with a strong, long-serving CEO, you have got all the attributes for a potentially lucrative investment.

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