Surely the simplest way to become rich in the stock market is to find the perfect young growth stock, fully invest, and ride it for 30 years. But a piece in the FT at the weekend caught my eye which illustrated just how hard it is to find long term winners in the market. The piece highlighted the biggest winners in the UK over the last 30 years - an unusual selection of stocks which certainly didn't fit the expected profile. The truth is that near perfect companies are very hard to find, and when you do find them, they are often acquired or taken private, leaving little of the long term reward in your pocket. Anyone screening the market to find the ideal stock may find their labours are only rarely rewarded. What is an investor to do?
The profile of a perfect buy and hold stock
Many investors will agree on the characteristics of their perfect buy and hold stock - it often goes something like this:
- high growth rate (EPS, Sales)
- low valuation (PE ratio, Price to Book, Price to Cashflow)
- high profitability (Return on Equity, margins)
- consistent, sustainable upward trend in profitability
- low leverage, good interest cover
- Mid-cap (with room to grow) rather than a 'penny' stock
- Good price performance in last year - low volatility of share price
Intuitively one imagines that a stock continuously showing a profile like this over many years will strongly outperform the stock market. It would look like a classic 'GARP' stock (growth at a reasonable price). The trouble is that everyone knows this. It's so very obvious that these characteristics are desirable that thousands upon thousands of investors look for them on a daily basis.
As a result, stocks often display a profile such as this only fleetingly - as when investors do find them they get bid up to a premium, reducing the future returns for new investors, and ensuring they drop out of candidacy from the list.
So what is an investor to do? Many will seek to be patient, alert and pounce on the opportunities when they arrive. Some such as Warren Buffett will step in on bad news, or when the macro environment looks frightening to others. But in regular times, for those who can't watch the market like a hawk, there is indeed an answer.
What if, instead…