Q: There are literally dozens of metrics I can use to evaluate stocks. What would you say are the most important things for long-term investors to look for when choosing stocks to buy?
There are plenty of useful metrics you can use to evaluate stocks for long-term investments, but many don’t apply to all situations. For example, the P/E ratio might work well when evaluating established, profitable companies, but it doesn’t apply well to rapidly growing companies that trade for high multiples of their earnings.
However, there are a few characteristics that I look for in any stock I’m considering for a long-term investment.
First and foremost, I try to qualitatively identify a company’s sustainable competitive advantage. Some investors refer to this as an economic moat, and this refers to the “x factor” that should allow a company to maintain or grow its market share and pricing power over time. Examples could include a valuable brand name, proprietary technology, or efficiency advantages, just to name a few.
Just to give you an idea of what I’m talking about, Coca-Cola (NYSE: KO) has a valuable brand name that gives it pricing power over rivals as well as a massive and efficient distribution network that lets it get its products around the world in a cost-effective manner.
If I can’t identify a sustainable competitive advantage, I’ll typically move on to another stock.
The second thing I look at is a company’s balance sheet. Now, I’m not necessarily looking for debt versus no debt but, rather, a reasonable debt level for its business. In other words, by comparing the debt metrics (debt to EBITDA, interest coverage ratio, etc.) of several companies in the same industry, I can generally determine if a company’s debt load is reasonable.
Obviously, there’s a lot more to buy-and-hold stock investing than these two concepts. However, using these can help you narrow down a list of long-term investment candidates before you dive deeper into any analysis.
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