Five Ways to Find Winning Long-Term Investments

Image: Gene Devine

While many investment books and financial advisors talk about the concept of getting compounded returns, the key gaining this magic lies in investing into companies that consistently have an edge over others. They should also be able to grow their revenue, profit, and/or cash flow over the long term.

Many companies may appear to have such characteristics, but investors have to dig deeper. It’s important to monitor investments to ensure the original investment thesis continues to be on track and the risks are contained or mitigated. Here, I draw up a few questions that investors should ask themselves, in order to find plausible long-term winners. I believe these five aspects should stand investors in good stead to find growing companies that can compound their wealth.

1. sustainable Business

Companies are all jumping onto the bandwagon and hoping that their business activities are all aligned to one or a few of ESG (environmental, social, governance) goals. While such actions are laudable, it is important to examine whether these companies are merely paying lip service or really aligning their core activities to the long-term sustainability of their business.

For example, is an oil company really investing more resources into developing renewable energy, or just doing it out of political pressure or general demand for cleaner and more efficient resources (but less profitable)? How about a financial institution who has a huge team of compliance officers to take care of risks and legalities, but has a cult CEO who can override and sign off on risky practices?

2. Growing addressable market

The second method is to search for companies with growing total addressable markets (TAM). In short, TAM represents the revenue opportunities for companies within a certain industry. If the TAM is large and growing, this implies there are ample opportunities for companies within that industry to enjoy multiyear growth, assuming they carry out appropriate business development and engagement initiatives.

This is in contrast to a company with a shrinking TAM, as that company will struggle to grow revenue and profit on a year-on-year basis. To give an example, a local healthcare company can have a growing TAM as more and more countries face an aging population and rising middle class demanding better healthcare facilities.

3. Consistent free cash flow

The third method relies on consistent free cash flow generated by a stable business. With such stability and consistency, investors can rest assured that their investment will not go off the rails. A great example of this is VICOM Limited (SGX: V01), which has generated very consistent and regular free cash flow for many years. This underscores the group’s ability to extract great cash flow from its business, which provides assurance of the company’s quality.

4. Clear and Candid dividend Payments

If a business has been increasing its dividends over the years, this implies the underlying business must be showing improved performance. The main reason companies bump up their dividends is because management is confident future growth will be able to fund the rising dividend. This sends a signal to investors that the company is on track for better days ahead.

5. prudent and Visionary management team

Lastly, look out for an astute and prudent management team with a long-term business horizon. This is more of a human aspect rather than a purely quantitative approach, but it’s important as it can determine if an investment performs well or not over the long term.

Management who are brash and go for fast but unsustainable market share gains tend to prioritize growth over prudence. Many use leverage to do this, especially during the era of cheap credit. This may cause the company’s share price to rise quickly but burn badly if things fall apart. One example is Ezra, which took up huge debt at one point in time, but when the oil and gas industry turned, it was not able to get enough business and have sufficient cash to pay off debtors.

An example of a company with prudent management is Frasers Centrepoint Trust. The management team always ensures there it does not always push the limits of its gearing ratio. That could be the reason why its share price has been somewhat resilient compared to other Reits.

The information provided is for general information purposes only and is not intended to be personalized investment or financial advice. 

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