Every investor is looking for the next home run stock -- the kind of company that will put up portfolio-making, life-changing returns.
Thankfully, we can look at some of companies that have put up stellar returns over the past few decades, companies like Amazon and Apple, and note some of the traits investors should look for to identify monster stocks in-the-making.
In this video from our YouTube channel, we break down some of the key things we look for in order to separate the wheat from the chaff.
Transcript: Hi, I'm Emily Flippen, an investment analyst with The Motley Fool. On this FAQ we're going to answer the age-old question of how to find and invest in really great companies like Apple and Amazon.
There's no doubt that great companies continue to provide value for investors. Over the past five years FAANG stocks (Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Google (NASDAQ:GOOG)(NASDAQ:GOOGL)) are up an average 219% versus the market's 48%. In fact, these large companies continue to drive most of the growth that investors see in the markets.
Although these companies are now household names, they weren't always the golden child for investors. So how do you, as an average person, find great companies like Amazon early on and enjoy 500% or 1000% returns on your money?
Well, to start, you need to remember that you're buying a part of a business, not just a ticker. When you are buying companies, you should be looking to make long-term decisions. You should plan to be buying a part of that business and holding it for years --preferably as long as possible-- but at least 5 years.
For reference, Amazon shares lost more than 90% of their value during the dot-com bubble at the turn of the century. But long-term buy-and-hold investors won out. If you had bought Amazon at the peak, right before the dot-com bust but held without selling, you'd still be up nearly 1600% today.
So, when you think about buying businesses instead of tickers, that leads you to look at important factors such as management and sustainable competitive advantages instead of short-term market noise. That's how you find great companies.
Would you ever give your money to a friend or coworker you didn't trust? The same is true for investing. You should find leadership that is trustworthy, inspirational, and dedicated. Look for businesses with missions you appreciate and management teams that have their compensation tied to long-term business results. That way their incentives are aligned with yours.
In Amazon's first shareholder letter, Jeff Bezos wrote:
"We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position... Because of our emphasis on the long term, we may make decisions and weigh trade-offs differently than some companies"
Amazon's management made its position and focus clear, and as investors that kind of vision and transparency is precisely what you want from a company's leadership.
Once you've found a company with management that you like you then have to evaluate the business.
Here at the Fool we look for a variety of things. But one of the big ones is businesses that are benefiting from long-term undeniable trends. When you think about the business, do you see it being bigger and more relevant 5 years from now versus today? If the answer to that question isn't a resounding yes, then you probably shouldn't invest.
For example – Amazon has grown to a near trillion-dollar valuation thanks to several huge trends – it's benefited from the rise of e-commerce and cloud computing. Investors that recognized those trends and Amazon's growing market leadership in retail and the strength of its web services business quickly realized there was plenty of growth ahead for Jeff Bezos and company.
Additionally, we look for companies with a strong and solid financial position that will allow them to continue to finance their operations. Therefore, we look for businesses that have reasonable levels of debt, strong operating cash flows, and high returns on invested capital. These are the things that enable companies to continue to run their businesses -- which is vital for shareholder returns.
Lastly, it is so important to invest in a company that has a special edge. This is a hard thing to quantify- in fact, with most great companies you can't find their competitive moat in numbers alone. But you should always know what makes that company stand out from its competitors; what they do differently that prevents anyone else from taking over.
In Apple's case, it's the company's brand and its incredibly sticky ecosystem that spans all its devices. The company has engineered products that people love and once someone buys an iDevice, they tend to be an Apple customer for life.
As you can probably tell, we're looking for best-in-class companies, and those kinds of businesses rarely look cheap. A great company will usually always have a premium attached to it, which is why we rarely let valuation alone prevent us from getting in on a great company early.
We hope this helps you get started on your investing journey! As always, thanks for watching. If you have thoughts on how you go about finding great companies, drop them in the comments section below. And if you have an idea for another video, let us know!
If you're looking for more info on investing, check out our investing starter kit at Fool.com/Start – it covers everything from saving money to buying your first stock and it comes with a 5 stock sampler to get you started.
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