With so many options, selecting stocks can be a challenge for the average investor. While each individual’s goals may alter their investing framework, having a clear set of rules can help. The following are six basic rules to consider: Rule One: - Invest in stocks that offer an easy-to-understand, fairly straightforward company business model.
Examples of this rule include McDonald’s (NYSE: MCD), Apple (NASDAQ: AAPL), and Starbucks (NYSE: SBUX). If you happen to have or understand specific industry knowledge about a company that other investors might find complicated these stocks are also worth a look for your investing universe. (Read about trading a Chinese rate cut here.)
This piece of advice is one of the hallmarks of Warren Buffett‘s long-term investing philosophy. Berkshire Hathaway‘s (NYSE: BRK-A), (NYSE: BRK-B) largest holding, after all, is Coca-Cola (NYSE: KO) – a company many recognize as a solid and trusted investment. Rule Two: Invest only in companies that are “best in breed.” This includes companies that have tremendously-established brands or that have extremely strong emerging brands. This is key. Keep in mind that in some sectors, the concept of “brand” means less than in other areas of the market. Branding, for example, means less in the mining sector than it does in retail.
Overall, it is best to stick with preeminent, ubiquitous, and highly-admired brands as well as underweight sectors where these stocks are hard to find or do not exist. When investing in less “brand conscious” sectors, however, stick with the “best in breed” companies and follow the other parts of the strategy highlighted here.
The concept of brands being “moats” around businesses is something that Buffett has spoken about in-depth. Furthermore, if you look at many of the best performing stocks in history, all have one thing in common – a tremendous brand. In addition to the stocks mentioned under the first rule, consider some other examples:
Nike (NYSE: NKE), Ralph Lauren (NYSE: RL), Google (NASDAQ: GOOG) and Pepsi (NYSE: PEP). While you might not have Buffett’s assets after investing in these stocks over the last five or 10 years, you have likely trounced the market. Rule Three: While the old investing axiom, “past results do not guarantee future performance” is true – and frequently repeated – it is also misleading. In order for a stock to meet the criteria of this investing strategy, it has to be a strong past performer. It doesn’t have to be up over the last year or even a couple of years, but the long-term chart has to be compelling.
Ask yourself the following: do you want to invest in a business, brand, and management team that has destroyed shareholder value over the long-term, or the one that has made shareholders rich? The answer is obvious. Simply put, buy stocks that fit the above metrics and that have performed well over a substantial period of time. If you are screening for tremendously-established brands as well as rapidly-emerging brands, this shouldn’t be a problem. Most companies that fit this profile have a great long-term track record of creating shareholder value.
Rule Four: Invest in mid-cap and large-cap companies and try to avoid small-cap names. This isn’t an edict, as there are some great small companies that would fit into this investing framework, but make sure that most of your picks conform to this advice. Like many of the tips provided here, it is from the Benjamin Graham and Buffett school of thought. Furthermore, if you are investing in “best of breed” companies and preeminent brands, following this rule shouldn’t be a problem.
Rule Five: Try to focus on companies that pay out dividends. Again, this is not an edict. The recommended stock provided in the follow up article, for example, does not pay a dividend. Industry bellwether Apple only recently announced a dividend, despite fitting seamlessly into this investing framework in every other way. Google also does not pay a dividend, but again is a highly recommended stock according to this investment philosophy. As a rule, just make sure that a majority of your portfolio’s companies pay out a quarterly dividend.
Examples of great dividend stocks that would fit this framework include Altria (NYSE: MO), owner of the Marlboro cigarette brand, and competitor Reynolds American (NYSE: RAI), owner of the Camel brand. Rule Six: Ideally, you want to buy stocks that fit this framework either on significant market pullbacks or when the stock is breaking out from a large consolidation area or base. The idea of buying on breakouts from large basing areas comes from legendary investor and founder of Investor’s Business Daily William O’Neill’s CAN SLIM strategy. In particular, look for this pattern with emerging brand stocks and try to buy the more established companies as cheap as possible to hold onto for the long haul.