Let's get one thing straight: To get obscenely rich in the stock market with a buy-and-hold strategy, you need to own the best companies. There's no other way around it. But how can you determine what the truly best companies are?
I'm here to tell you that there are five simple characteristics shared by every single one of the best companies on Earth. If you can identify these five traits and have the discipline to invest at the right times (and perhaps sell if things change), you'll never have to worry about money again.
The fab five
Without further ado, the five traits are:
- Creation of high utility for customers
- Something special
- High rate of innovation
- Excellent managers
- Efficient operations
It sounds like a basic list, but when you come down to it, business is basic -- the production of a good or service for a customer. The quality of a company depends on how useful its product is, how defendable its markets are, and how fast it can produce new and better products. Solid management and cost-effectiveness are musts as well.
The fab five, one by one
Let's examine each trait and look at some examples:
"Creation of high utility for customers" means producing a good or service that customers value very highly, or literally can't live without. A perfect example is Rockwell Collins (NYSE:COL), which produces navigation and landing guidance systems for airplanes. I don't know about you, but I'd say any piece of equipment that allows a plane to land creates a lot of value for airlines and passengers. This, in turn, creates steady demand for Rockwell Collins' products.
"Something special" is intentionally broad, because this trait comes in many forms. The company needs this little bit extra to maintain its advantage and inhibit competition. It could be a patent, a secret ingredient, or a network effect like those at Visa (NYSE:V) or American Express (NYSE:AXP), where the bigger the network gets, the more advantages the company accrues.
"High rate of innovation" relates to how a business must constantly improve to stay ahead of its rivals. An excellent example is Apple. I recently dug my first iPod out of a box and was amazed at how clunky it is. Plus, it only has 10 gigabytes, whereas the new models have 120 gigabytes -- 12 times as much, and, I'm embarrassed to say, more than my home laptop.
"Excellent managers" is self-explanatory. A company is only as good as its assets and the people using them. General Electric is a great example; it spends an estimated $800 million every year on educating its employees and managers. As a result, GE enjoys dominant market positions and boasts highly regarded managers, who rank among the most sought-after executives to lead other companies. Another well-run company that comes to mind is General Dynamics (NYSE:GD), a defense contractor had the foresight to sell off businesses in the early 1990s when the defense budget was shrinking -- and then buy businesses later, when the budget was rising.
Finally, the company needs to "operate efficiently." This enables the company to earn enough money to focus on the first three traits. The pioneer of efficient manufacturing is Toyota (NYSE:TM), which was the early adopter of lean manufacturing and kaizen techniques. Other companies, such as aerospace and industrial components supplier Parker Hannifin (NYSE:PH), have excelled at lowering costs by using the same techniques.
Start investing
That's it. The five characteristics of each truly brilliant business on this planet. They are self-evident, yet ever-so-difficult to obtain and hold.
I encourage you to think about every company in this light. How much value does it really create for the customer? Can it do something no one else can do? Is it well-managed? These questions are simple, but the implications are very deep, and if you can check off even four out of five boxes, you'll likely have a winner on your hands. This list may even enable you to spot the next Wal-Mart (NYSE:WMT), which has truly earned a place among the best companies on earth.
This is all we do at Motley Fool Inside Value -- focus on identifying companies with these characteristics, and pick our spots to invest in them. We're extremely pleased that many of the world's best businesses are on sale now.
Good luck investing! If you need help, consider taking a 30-day guest pass to Inside Value. You'll get all of our recommendations, including our five best ideas for new money now, as well as a discounted cash flow calculator you can use to evaluate companies on your own. Click here to get started.
This article was first published March 1, 2009. It has been updated.
Fool analyst Andrew Sullivan has bullish option positions in American Express and General Dynamics but has no financial position in any of the other stocks mentioned in this article. American Express, Rockwell Collins, and Wal-Mart are Motley Fool Inside Value selections. Apple is a Motley Fool Stock Advisor recommendation. The Fool owns shares of American Express. The Motley Fool has a disclosure policy.
