Long-term investing is a concept known to many investors. Its advantages are indisputable. Money works over time – at least in theory.
The practical challenge is to find the businesses that benefit from time; the companies that grow and provide their shareholders with returns, year after year. In this article, we’ll briefly discuss the criteria that a long-term investor should focus on and how the price of a stock is affected by long time horizons and the quality of the company.
We have also written a 20-page guide about Long-Term Quality Investing
Five key quality criteria for long-term investors
We use the following five qualitative criteria to evaluate companies for our portfolio. We also have a long list of more detailed qualitative and quantitative criteria that every investor should take into account.
- The company’s earnings model has clear competitive advantages that explain margins and profits that are higher than those of competitors.
- The industry is growing – more than 60% of the company’s future growth is attributable to industry growth.
- The company’s profits show stable growth and predictability for more than five years.
- Revenue is recurring (licenses, maintenance services) – enables the stability of profits even during economic downturns.
- High return on equity – when the return on invested capital (ROIC) is over 15%, it works wonders in terms of profitability over time.
Let’s look at these criteria in the light of a real-world example.
Case Starbucks – what is the effect of long-term investing in high-quality company?
When a company’s profit performance is stable, we know it has the capacity to invest in growth through product development, marketing or geographical expansion, for example.
High return on invested capital, in turn, tells us that the management has the ability and the resources to make profitable investments in future growth.
For instance, Starbucks, the world’s largest chain of coffee shops, has maintained a return on invested capital (ROIC) of 25–35% for the past 10 years.
In other words, the company has invested a significant proportion of its profits into its business by increasing the number of coffee shops, launching new products, expanding into China, and developing new digital services. The investments have been sound, as evidenced by the company’s profits growing by an average of 16% per year (2010–2019) before the COVID-19 pandemic.
The share price has followed the money, i.e. the company’s growing profits.
Sifter Fund invested in Starbucks in January 2018 and made additional investments during Q2 and Q3/2020. Although the coffee shop and restaurant business was hit hard by the restrictions introduced in response to the pandemic, Starbucks recovered surprisingly quickly. We believe the company was able to strengthen its competitive position during the COVID-19 pandemic and will be even stronger in the future.
Want to read more cases? Download our guide: Long-Term Quality Investing. In the guide, we explain Sifter’s approach in more detail and cover five cases that exemplify the high-quality companies in the Sifter portfolio.
When does long-term investing not work?
Investors sometimes fret about having added companies to their portfolio several years ago and still not seeing a profit. When they hear that others have performed better and index investing has generated great returns, the feeling is even worse. When a stock performs poorly for several years, it is usually a sign of the company having unresolved problems.
Perhaps the investor bought the shares for emotional reasons, seeing that the price has come down and expecting it to go back up.
Buying on emotion is a common psychological trap. A long-term quality investor buys shares based on careful analyses. If a company is on the ropes, even giving it a lot of time may not work to your advantage.
Long-term quality investing is an apt description of Sifter’s investment strategy
The importance of diligent company analysis is emphasized when you’re building a long-term portfolio. The stocks selected for the portfolio must be companies that benefit from time and are able to withstand the unpredictable and inevitable turbulence in the market.
Are you interested in long-term investing? Download our 20-page guide: Long-Term Quality Investing to learn more about how time and high-quality companies work in the investor’s favor.
CEO, Sifter Capital Oy