Investing in stocks is a lot like building a fire to keep you warm, with some materials performing better than others. You can get a real nice flash from setting paper alight. But it doesn’t last long enough for you to sit back and enjoy the warmth, forcing you to repeatedly go out and find some more. A nice thick log does the trick. It lasts longer, which means less work and more relaxation.
So goes for stocks. You might get a great return from fad stocks that flash brilliantly for a while, only to find yourself poking at their ashes wondering why they fizzled out so quickly. It is then that you realize those unspectacular, slow burning stocks can last a lifetime, giving you all the financial comfort you could ask for.
But how do you spot the right long-term stocks? And just how much of an impact can they really make on your savings?
Criteria and Benefits
It should be noted that just as there are different fuels for different furnaces for different purposes, so too there are a variety of investment vehicles for a variety of portfolios for a variety of investment objectives. Much depends on your age, current needs, and future goals. So we mustn’t presume that one set of criteria will be ideal for all.
Long-term stocks, therefore, are just one part of a typical portfolio, the proportion of which will vary according to your needs and goals. Once you have determined how large an allocation you want to make to these slow and steady burning long-term stocks, you might then scan for the following three major criteria:
Solid future demand: Look for companies whose products and services will be in demand for a long, long time. But you don’t need to get overly complex in determining people’s future needs. Stick to the basics, like food, retail, healthcare, automobiles, telephones, electricity, gasoline, building supplies – the list is long. Often these are your boring companies that don’t have hip or pizzazz. But they sure can grab your attention when you look at your investment statement at the end of the year.
Cash flow: You can’t last long without money, and neither can companies. A large debt balance hiders a company’s ability to acquire, innovate and grow. And in a rising interest rate environment such as we will soon be in for the next 10 years or so, servicing a large debt burden will only cost more with each passing year. A company that manages to consistently generate surplus cash flow will likely be around long enough to see you through your retirement.
Dividend payouts: A long history of reliable dividend payouts is the hallmark of a solid, prosperous, and well-run company, as usually only mature companies can afford to pay them. They are a sign of positive cash flow and stable market share, and they can accelerate your portfolio’s growth significantly. The average dividend yield in S&P 500 and Dow Jones companies is about 2.5% per year. When reinvested, dividends alone can grow your investment by 28% over 10 years, 63% over 20 years, and a whopping 137% over 30 years – not including the stock’s capital appreciation.
What you won’t get from these typically mature, large cap stocks, however, is those explosive spurts of growth, such as have been delivered recently by some tech and internet stocks. But remember that what you are getting instead is stability. A lot of darlings have flashed with a roar like paper and kindling on a fire, only to end up as heaps of charred ash.
While there is room in a portfolio for those quick one or two year investments, room should also be made for companies with longevity, those slow burning logs that keep you snugly warm for decades, and that pay you cash to supplement your retirement income.
Funds and ETFs
While you can have the odd success conducting your own research and trying your hand at picking the right stocks, chances are your portfolio will grow faster if you rely on some professional assistance. Since full brokerage services can cost a small fortune, you might find mutual funds and ETFs the next best thing.
The advantage of mutual funds and most ETFs is that they spread the risk over multiple stocks within a sector or even across multiple sectors. You can pick small cap funds for those short term brilliant and spectacular flashes, and large cap funds for those long lasting dividend payers.
Funds offer a measure of protection against failing stocks. If a once solid and prosperous company takes everyone by surprise and keels over in an unimaginable Titanic-like sinking, your portfolio wouldn’t be shipwrecked, as the fund will simply replace the ailing stock with another. Investing in sector or index funds, then, is investing in the sector or index itself, which gives your holding greater longevity still.
A timely case in point is the SPDR Dow Jones Industrial Average Trust (NYSE: DIA), one of the largest ETFs of them all, tracking the 30 large cap behemoths that comprise the Dow Jones Industrial Average. Unsatisfied with the performance of several stocks in the basket, the index recently decided to replace three of its holdings – a solid 10% of the portfolio. Holders of the ETF not only benefit from expert professional management and regular rebalancing of holdings, but also from a decent 2.5% annual yield paid in monthly disbursements.
Other major index ETFs include the SPDR S&P 500 ETF Trust (NYSE: SYP) tracking the S&P broader index, and the PowerShares QQQ Trust (NASDAQ: QQQ) tracking the NASDAQ 100 index – averaging annual dividends of 2.5% and 1.5% respectively, paid in quarterly disbursements.
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While these are great long-term ways of investing in American large cap companies, fund managers are encouraging investors to look to select foreign markets as well, some of which have recently been issuing economic stimulus packages of their own. We already know how stimulus in the U.S. over the past five years has fanned an enormous fire under equities, lifting the S&P index some 158% since 2009. Foreign markets give us an opportunity to jump in near the beginning of their own stimulus-induced multi-year bull runs.
Since Japan’s Prime Minister Abe introduced his economic stimulus package in late 2012, funds have been moving into Japanese stocks in droves, lifting the Nikkei Index of 225 large cap Japanese companies 68% higher over the past 11 months.
Among individual companies in emerging markets, investment giant Morgan Stanley (NYSE: MS) recently unveiled a list of 20 large cap stocks that it believes will be great long term holds until at least 2017. As expected, they cater to those previously noted long term future consumer needs, including:
Electricity: China Longyuan Power Group – supplying 17% of China’s wind power. Given China’s plan to move some 500 million rural residents to cities over the next 10 years, the nation’s electricity demand will just keep growing.
Mobile phone service: Idea Cellular – the fourth-largest mobile service operator in India. For emerging nations like India, where telephone infrastructure is prohibitively expensive, mobile telephone will long be the ideal communication service of the future.
Automobiles: Maruti Suzuki – one of the faster growing auto manufacturers in India. India’s auto industry – ranked the world’s 6th largest producer and 4th largest exporter – is closing in on 4 million new vehicles a year, about one-quarter of America’s production. In a nation three times more populous than the U.S., India’s auto industry has a tremendous future indeed.
Entertainment content: Grupo Televisa – Mexico’s second largest multimedia company, and largest Spanish language content producer in the world. Spanish being the second most widely spoken language in the world native to over 400 million people, you can bet that Spanish language entertainment is not going away anytime soon.
Yet while investing in foreign markets can provide long term growth potential, gains will be eroded somewhat by the tendency of foreign currencies to depreciate against the U.S. dollar. One should always consider the “opportunity cost,” a comparison of your current investment’s returns versus what you could be earning somewhere else.
But even if you invest solely within your own country and do not have any currency fluctuation issues to cut into your returns, you should still consider the opportunity costs of the choices you make. The opportunity cost of short term flash-and-burn stocks can be pretty costly compared to all the returns you could be enjoying from a divided-paying, more mature company providing products and services that will remain in demand for decades to come.
Boring as those companies may be, their long term contribution to your nest egg will surely make you take notice.