Investing in the stock market is one of the best actions you can take to build long-term wealth. But it can seem like a daunting task at first. After all, where does one even begin when looking for individual businesses that can perform well over time?
I believe the entire process can be simplified, especially for newbies. The ultimate goal should be to develop your skills so that you can get better as time passes. And there's a good place to start. If you're looking for winning stocks, follow this simple rule.
Think like a customer
Don't underestimate your own personal experiences. Think about the places where you shop, or the restaurants you frequently eat at, or the subscriptions you signed up to use. Put yourself in the perspective of a customer. This should immediately help you come up with a list of businesses.
You can take it one step further. What products or services do you hate? What products or services can't you live without? What companies gave you such a terrible experience that you will never give them your money again? What companies delighted you so much that you gladly told all your friends and family about them?
It's really a simple exercise, but if a business has served you well, then it might be deserving of a closer look from an investment perspective.
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At the top of their game
It shouldn't be hard to identify businesses that fit the criteria mentioned above. In fact, there are three perfect examples I can immediately think of today. All have found tremendous success by always putting customers and their needs at the top of the priority list.
Chipotle Mexican Grill, Costco Wholesale, and Netflix are businesses that you should have on your watch list, if you don't already. They provide their customers with a compelling value proposition. In fact, thanks to their proven pricing power (Chipotle raising menu prices, Costco occasionally hiking the annual membership fee, Netflix increasing the monthly subscription cost), it's clear that consumers believe they are getting much more value than they pay.
It's not surprising that all three stocks have soared in the past 10 years, handily beating both the S&P 500 and the Nasdaq Composite.
Understand the market's expectations
Just because you've found a company that sells superior products or services and has produced strong fundamentals and a stellar stock performance, it doesn't automatically mean you should buy shares. You must also consider how the market views the company. In other words, it's critical that you understand what valuation you're paying.
Let's look at the three stocks I mentioned more closely with this lens. With Chipotle shares trading at a forward price-to-earnings (P/E) ratio of about 54, I think it's easy to argue that the stock is extremely overpriced today. This is true even when you consider management's goal of doubling the store count in North America over time.
Costco trades at a forward P/E multiple of about 45, which is more than twice the valuation of the S&P 500. The company is already a massive entity, today the world's third-largest retailer, so I don't expect growth to be fast enough to justify paying such a steep valuation. Netflix might be the only stock that's reasonably valued right now. It trades at a forward P/E ratio of 31. I think this makes it a worthy investment candidate.
Finding the right business is one piece of the puzzle. Following the rule of searching for companies that take care of their customers is a fantastic place to start. However, don't forget to pay the right price as well.
