We live in uncertain times, but it's still crucial to invest in order to meet our long-term financial goals. So if you're looking to invest $1,000 right now, it would behoove you to focus on companies that should have good business results not only over the long term but also during this uncertain short term.
But how can investors spot these fast-growing, high-quality companies built to last? Looking for the following two characteristics will put you on the right path.
1. High-quality growth with big runways
The best companies to own for the long term are the ones that should continue to grow their revenue and profits for a very long time. That sounds obvious, but instead, many investors look for stocks that appear statistically cheap, regardless of the companies' long-term prospects. That's usually a mistake because we never know if or when a "too cheap" stock is going to revert to being fairly valued. That depends on a meaningful improvement in the status quo for an average-quality business, which is far from certain.
The beauty of high-quality "compounders" is that regardless of what their stock prices may do in the near term, we can be more confident that these companies are growing their underlying business values. That may not show up in their stock prices next week or next month, but if we're right about the business, it will likely show up given sufficient time. That's a huge advantage for an investor because it provides confidence to hold the stock through the inevitable day-to-day volatility.
Netflix headquarters in Los Gatos, California. Image source: Netflix.
2. Resiliency amid turbulence
There's tremendous uncertainty given the COVID-19 pandemic and what impact it may have on our economy. We have seen a jaw-dropping rise in unemployment, and there's much debate about the shape of the recovery, how quickly things improve, and what impact a potential second wave of infections may have. None of us has a crystal ball, so it's prudent to add a second criteria to our starting point of high-quality stocks with big runways.
The second criteria is the companies we invest in should either be seeing an improvement in business because of the current environment or at least no noticeable harm. They should be resilient even during uncertain times. Some companies that come to mind are those that benefit from a largely housebound culture, working-from-home lifestyles, and/or home-focused spending. We simply don't know how long this downturn will last or how deep it will get, so it's wise to own businesses that will do fine even if things get worse.
Two examples
One of the most obvious high-quality growth companies with a big runway while benefiting from the current environment is Netflix (NFLX -3.92%). Many assume Netflix is already ubiquitous, but its global base of 183 million paid subscribers is still very small relative to what it could or should be in the distant future. And its profit margin potential is enormous given its fixed-cost content deals coupled with its massive global opportunity. We can already see that dynamic beginning to play out in the company's operating profit margin, which has risen from 4% in 2016 to 13% last year and management's guidance calls for 16% this year.
The company is clearly getting stronger from our current environment as much of the world's population is staying at home more than usual. As a result, more new households around the world are subscribing to Netflix and fewer existing subscribers are canceling.
At first, one might think many of the recently unemployed would cancel a discretionary service like this, but it doesn't seem likely given Netflix's attractive value proposition. The Standard plan, at an affordable $12.99 a month, provides unlimited ad-free, on-demand entertainment. People are spending less going out to the movies, restaurants, bars, and other places, which should allow more than enough room in the budget for Netflix. In addition, households are more likely to cancel their far more expensive cable TV packages than their modestly priced Netflix subscription.
Amazon.com (AMZN -1.64%) is another company that meets both these criteria. Despite the company's size and relevance to many of our lives, it still has only about 1% of the $25 trillion global retail market. And despite the incredible growth of Amazon Web Services (AWS), which has grown from an internal start-up in 2006 into a $41 billion annual revenue run-rate business today, it only accounts for a tiny fraction of the $3.7 trillion global IT market. Clearly, the company has long runways to grow in its two core businesses.
And it has other big growth opportunities: advertising, global logistics, healthcare, its Echo smart speakers, Amazon Go brick-and-mortar retail technology, and a laundry list of other initiatives and investments.
Amazon is clearly strengthening as a result of the pandemic. Beginning in March, it began to see demand rapidly accelerate to the point that it couldn't keep up. The company quickly hired 175,000 more employees in fulfillment and delivery roles to help catch up. On its first-quarter conference call, management suggested the company would begin being able to fulfill demand starting in the current quarter, although it admitted it was hard to predict the exact timing. Regardless, it's only a matter of time before Amazon catches up with demand, which should result in surging sales growth.
Netflix and Amazon are not the only companies meeting these two criteria. Wise investors looking to put $1,000 to work should be able to identify other potential investments by looking for growth companies with big runways.
