Steadfast FinancesHow I Pick the Best Long Term, Buy and Hold Stocks

How I Pick the Best Long Term, Buy and Hold Stocks

Filed in Index Funds , Investing 101 , Long-Term Stocks 5 comments

I’m something of an oddity in the investing world when it comes to finding the best buy and hold investments: I do not limit myself to a one individual method of stock analysis.

In other words, I’m not 100% reliant upon fundamental analysis where I only review the financial statements and read the 10-Ks, nor am I only using technical analysis where I’m annotating charts, looking for bull flags and only buying at technical support levels.

So instead of being confined by the parameters of an individual methodology, and the specific weaknesses each method possesses, I prefer to take a gauntlet like approach where a collection of stocks will face a series of 4 uniquely different challenges, and only the best companies who get top marks in each challenge will be considered as a potential long term investment.

This way, I can be relatively certain I’m getting reasonably good value for my money, buying at a price with a more upside potential than downside risk, while also investing in a company with a solid business plan poised to improve their bottom line and grow their company.

Why This Concept Works

The crux of my technique is fairly simple: you whittle down thousands of companies and only select from those companies that get top marks (think “A” students above the 90th percentile) in each category.

In this sense, it’s much like that of selecting the best possible candidates to attend professional schools (medical school, law school, etc.) or top 25 business schools where you only take those students that managed to make themselves the cream of the crop by getting the highest grades as possible, doing very well on their entrance exams, so on and so forth.

Hence the use of a Venn Diagram (although overlapping circles are normally used) with four similarly sized boxes with a small overlapping diamond in the center to illustrate the difficulty in finding a few stocks that get top marks for each investment category.

How I Pick the Best Long Term, Buy and Hold Stocks

In the graphic, you will first notice that there are two very different schools of analysis, a bargain hunting “buy on the dips” strategy that mimics value investing, followed by a “gut feeling” strategy that relies mainly on instincts and reviewing the ways a company makes money.

Without going into much detail, this is how I use the individual methodologies to quickly screen a potential stock as a solid buy and hold investment:

  1. Technical Analysis. The first thing you should do when to investigating any stock as a future investment is to pull a 10 year chart. This allows you to identify historical peaks and valleys, but also price levels that might serve as resistance levels or support levels where you should hold off on buying, or jump in headfirst because you just found a solid entry point. In many regards, technical analysis doesn’t serve as a solid way of identifying your entry point, but instead, tells you when you avoid the stock and wait for a better price.
  2. Fundamental Analysis. Like most things, the fundamentals never go out of style because they’re always useful. If you have a company with a low P/E ratio, good cash flow, high return on equity, low debt, and has a 30 year history of raising its dividend every year, then you’ve found a pretty stable company with a solid management team. However, just because a company looks good on paper, it doesn’t it is a good investment. For example, many oil and natural gas companies had great fundamentals during the oil bubble, but that didn’t stop them from losing half their value in six months.
  3. Buy on the Dips. Buying stocks on a price dip is like going on a shopping spree after the Christmas holiday. If you believe a stock has a positive future, but is suffering because of a downturn in normal business cycles or recently suffered a short term setback, then why not take advantage of the market’s generosity by buying one of your favorite stocks at a discounted price. This investing style takes patience, planning, and an ability to ignore the standard doom and gloom news, but it’s a very effective strategy for many value investors. For example, talk to anyone who bought GE under $5 per share or Citigroup under $1 per share.
  4. A Believable Long Term Story. Story stocks are those companies that have a long term, well thought out business plan that allows for future company growth, equity appreciation or raising of the company dividend. These are the types of companies that provide a product/service that will be in high demand for many years to come that will increase market share, require new employees, revolutionize the business environment, etc. Of course, you need to be a savvy enough investor to sort the bullish sales pitch from the bulls**t. Examples include Apple, Google, and Amazon.

Remember, this isn’t a catch all technique that you should run out and try yourself without any practice or training. If you’re a novice investor, you should begin by learning one strategy as well as you possibly can, then master the others as time allows.

If you’re an inexperienced investor or simply don’t want to put in the time to do the research yourself, you should highly consider sticking to the Plain Jane index funds or test out your investor skills by starting a stock market simulation game.

If you’re a stock picker, mind sharing any of your selection criteria or stock screening techniques that you use when picking buy and hold investments?

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Posted by CJ   @   29 December 2009 5 comments
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5 Comments

Comments
Dec 29, 2009
11:35 pm
#1 pfstock :

This article gives you a lot to think about. I still think that it is very difficult to find a perfect stock, even when you try to whittle down the choices to only a few. I’ve been trying with mixed success on my own approach. Nevertheless, I wish you the best of luck.
.-= pfstock´s last blog ..Links to Carnivals – December 28, 2009 =-.

Dec 30, 2009
12:27 am
#2 Matt SF :

Thanks PFStock. Much of the problem that I’ve identified with making my own investments is not waiting for the right buy on the dips opportunity. Once I started using this technique, the results began to improve.

Then again, one could buy the worst stock in the world, and as long as it appreciates and you get out at the right time, most people couldn’t care less how good the research was prior to investing.

Dec 30, 2009
12:37 pm
#3 Craig :

Definitely gives a lot to think about but I am still intimidated in the process and doing this with my lack of knowledge. Prefer something safer.
.-= Craig´s last blog ..Weekly Personal Finance Twitter Chat: Scholarships =-.

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