How to identify companies you can hold for the long-term (at least 10-20 years) in your portfolio?
Updated: Mar 19, 2022
Table of Contents
Some important things to look out for to identify companies you can hold for the long-run.
[Avoid or mitigate your holdings for these type of companies]:
2. Avoid companies which are slow to/ unwilling/ unable to innovate.
3. Avoid companies that have risks of being negatively affected by Antitrust policies.
4. Mitigate portfolio allocation for companies which have high level of Keyman risks.
5. Avoid companies which are heavily covered by short seller companies.
a. Companies who are already well established and have a large portion of the market share:
3. Look for companies that prioritize and embrace continuous INNOVATION.
Bonus: Great if companies in emerging industries have Branding power too.
4. Look for companies which have growing revenue from various geographical segments.
Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.
Benefits of holding long-term:
Ever wondered why Warren Buffett doesn’t sell his Coca-Cola shares for other “faster growing” or more “exciting” stocks even after so many years?
Have you ever wondered why super investor like Warren Buffett hangs on to his Coca-Cola stocks even though they are no longer “undervalued” (in the words of a value investor) or growing (in words of a growth investor)?
Many people wonder “why doesn’t he just sell his Coca-Cola and invest his earnings in other younger & faster growing companies?
The answer is simple, This is because of the enormous dividends yields he is acquiring from the stock.
Warren Buffett bought more than $1 billion worth of Coca-Cola stocks in 1988 (that is 20 years after they went listed).
Assuming he purchased Coca-Cola stocks at entry price of $2.39 at 1988,
Capital gains of 2,000+% aside in the past 30 years,
He is gaining up to 70% of returns per year purely based on Dividend earnings itself.
(Formulae):
(Price today x Div yield) / Entry price =
($51.44 x 3.27%)/ $2.39 = 70%
His Coca-Cola stock alone is generating about $700 million in dividends earnings every year for him.
And not forgetting the capital gains, Coca-cola stock also generated 10% of annualized returns for him from 1988 until today.
This is why Coca-Cola is Berkshire’s 3rd largest holding and also one of the best investments he has made.
Some important things to look out for when investing in companies that we can hold for the super long-term. (Good if its 10 years and above, better if its 20 years and above).
One thing to keep in mind before you start analyzing a company and deciding if you would like to add it into your portfolio or not.
If you think you can hold the company for at least 10 years, that’s good. If it is more than 20 years, that’s even better. If it is anything less than 10 years, then you should not consider buying the stock in the first place.
If you would like to reap gains like Buffett over the long run.
It is important for us to first engage in downside protection (meaning mitigating the risk factors involved), we do this by investing in companies that will not “Die” (meaning be bankrupt or be irrelevant and lose market share rapidly to their competitors in the industry) in the next 10 to 20 years- which will ultimately cause their share price to plunge and not recover.
[When engaging in downside protection, we ought to avoid companies that show these traits]:
1. Avoid companies with poor Balance sheet
Most importantly, we ought to avoid companies with high levels of debt.
For example, Netlfix albeit a fantastic company providing services which is arguably important in many consumers’ lives today.
Their high debt levels (Net Debt to Equity ratio of 96% and Debt to Equity ratio of 167%) today make them a rather risky company to hold for the long term.
General rule: I would avoid companies that have more than 100% of Net Debt to Equity.
You can check for their Debt to Equity ratio over here on Reuters website:
https://www.reuters.com/companies/NFLX.OQ/key-metrics
Look under ‘Key Metrics’ tab > ‘Financial Strength’ > ‘Long Term Debt/ Equity’
As for Net Debt to Equity ratio, the formula is = (Total Debt – Cash & Cash Equivalents) / Total Equity
Why is this a concern?
Since Netflix’s core service is to provide entertainment to their customers,
Their competitors do not only existing in the video streaming space but also any other forms of entertainment such as video games, social media etc.
If new forms entertainment arise in a rapid pace, or if their direct competitors come up with more attractive offerings or more innovative products which give customers better value for money, Netflix may not have a high level of flexibility to innovate fast enough- which requires a lot of cash to do so, due to their poor balance sheet position.
The recently launched Disney + which is selling their subscription at competitive rates may pose as a threat for Netflix’s business model.
And because Disney has a a lot more cash ($17 billion) as opposed to Netflix’s $8.2 billion, plus (no pun intended) it has a much stronger balance sheet (only 59% Debt to Equity Ratio). Disney + could be a major threat to Netflix when they decide to create more of its own contents on the platform offer their service at a cheaper price (engaging in price war) compared to Netflix.
2. Avoid companies which are slow to/ unwilling/ unable to innovate.
We also ought to avoid companies that have shown signs to be either unwilling or late to innovate (especially important in an industry where competition is high and constant R&D and product improvement is required when the market trend shifts).
Some examples of companies which failed to innovate in a timely manner in the past were Nokia and Kodak, who both used to hold close to monopoly positions in their respective industries and were eventually disrupted by new and smaller upstarts.
As for present companies like BMW, VW, Ford or Daimler (Merc) who are market leaders in their industry today.
It may be difficult to imagine there is a possibility that large automakers like them may lose their positions as market leader in the foreseeable future.
However, due to the shift in the industry towards trends of decarbonization, many countries like U.S, China, U.K and European countries are implementing policies to encourage the use of Electric Vehicles while discouraging the use of Internal combustion engine (ICE) models.
Currently for most of the automakers, the cost of producing EVs are very high, making this a low-margin segment for them. Since most of their revenues & profits are generated from selling ICE car models, coupled with their current high level of debts,
It makes it difficult for them to invest heavily in EV R&D efforts since selling EV vehicles will cannibalize their own ICE car segments, reducing the overall profitability of their businesses.
Avoid companies who are unwilling to disrupt their own business models before others do, because these are the companies who will become complacent and this make it difficult for them to innovate and embrace change in time in the future.
3. Mitigate or avoid companies that have risks of being negatively affected by Antitrust policies.
Although it is rather obvious that companies like Google and Amazon will very unlikely “die” in the next 10-20 years.
The downside for these large tech companies is that they may be hit with antitrust lawsuits where government may attempt to break them up or force their parent company to sell their subsidiaries to promote fairer competition in the market place.
For example, Facebook may be facing more antitrust pressures and scrutiny under President Joe Biden’s administration.
However, if you have:
already bought into some of these stocks at an earlier period at a much cheaper entry point, and
you have very high conviction in their one-of-a-kind business model and their growth potential, plus
you are willing to take the risk of their stock price potentially plunging significantly in the future if they are really broken up.
You can still allocate a small portion of your portfolio for stocks like these, preferably not more than 5-8% of your portfolio.
But if you would like to add stocks like these into your portfolio, and you have yet to buy them. I would advise not allocating more than 5% of your portfolio for stocks like these.
4. Mitigate portfolio allocation for companies which have high level of Keyman/ Key person risks.
Keyman risks exist when the corporation’s success is heavily reliant on a one or a few key individuals of the company.
This risk usually exists for newer companies which are either:
not very established in the marketplace yet, or
have yet to obtain a significant market share of the industry they are operating in.
And their key executives: i.e., the Founders or CEO of the company are playing vital roles in spearheading key projects to see through the success of the company.
i. Past case study: Apple
This was quite obvious in the case of Apple, when Steve Jobs was fired in 1985 and the company was in the brink of bankruptcy under John Sculley’s leadership in the few years which followed.
When Steve Jobs returned as CEO, he launched a range of innovative products including the iMac, iTunes, iPod, iPhone and iPad as well as Apple Retail Stores. In 2011, Apple became the world’s most valuable public company.
It is clear that Apple’s massive success was highly attributed to how Jobs led the company.
ii. Past case study: Amazon
Similarly, it is safe to assume that Amazon would not have been as successful as they are today if Jeff Bezos stopped serving as their CEO during the crucial times in their early days when they were battling industry giants like Barnes and Nobles.
iii. Current case study: Tesla
An example of a bright company with a reasonable amount of keyman risk today is Tesla,
Although Tesla has about 18% of the market share in the global EV sales as of Oct 2020 [v],
they only have about 0.8% if the total auto industry’s market share.
There are various sources attesting that Tesla’s EVs are indeed superior in terms of technical specifications and also when it comes to value for money for consumers at this point, but they still have a long way to go before they capture a significant amount of the total addressable market share.
And they need to continue to prove that they are able to stay ahead of the fierce and increasing amount of competition from large traditional car makers, which is no easy task.
Hence, I believe that if he leaves his role as the CEO of the company at this important time, it will negatively impact their company’s near and long-term trajectory.
Even if a few of their key important people leave the firm and join a potential competitor, taking away Tesla’s trade secret with them, this will have a adverse impact for the company too.
Similar to point 3 above, if you would still like to invest into companies like these (which possess a high level of Keyman risks),
I would advise that you keep them at no more than 10% of your total portfolio.
You can add more in the future however when their progress and ability in capturing the majority of the market share is becoming clearer.
5. Avoid companies which are heavily covered by short seller companies.
This is particularly relevant for companies where public information is not widely available and their released financial statements may not be as reliable.
Some examples in the past would include Luckin Coffee which reported fake numbers to entice investors’ interest.
Similarly Wirecard AG did the same by artificially inflating their profits,
(What you can do to avoid companies like these):
Do a quick search on google if the companies you are looking for is being covered by popular short seller companies like Muddy Waters, Blue Orca Capital, Bonitas Research and Iceberg Research.
You need not look into each of their website, just do a quick search on google in this format will do: “Company Name” + “Name of the shortseller companies” and see if any results come up.
If they are heavily covered, and you do not know much about and cannot find much reliable information about this company, it is best to just avoid them completely, there are still plenty of other companies out there you can look into.
Although short sellers may be disliked, the information they provide to the public may help prevent you from investing in potentially fraudulent companies which could lead to your capital loss.
[Traits to look for to identify companies that will be around for a long time]:
If the companies you are keen to invest in manage to pass through all the tests above,
you can now see if they display these traits below to increase your chances of ensuring they will continue to be around and perhaps thrive in the marketplace for long time to come.
So definitely:
1. On top of having a strong balance sheet:
meaning the company should have minimal or low amount of debt and
should have an increasing or healthy amount of Cash on hand too.
I.e. in the case of Adobe, you can see that their Cash & Equivalents amount is shown to be increasing
You can do this by searching for the company name + Reuters on google, And look under Financials > Balance Sheet
2. The company should show to have the ability to generate healthy and positive flows of Cashflow from Operation as well.
As a general rule, I would avoid companies which have negative operating cashflows.
And if their business model is very promising, I would keep them in my watchlist and only consider them seriously once their business turns around and show to have the ability to churn out positive operating cashflows consistently into the future.
This can also be easily checked through websites like Reuters:
Just search for the company name + Reuters on google, and look under Financials > Cash Flow tab.
Note: there are generally 2 type of industries which companies will operate in which investors will invest in:
They will be either:
i. Evergreen industries which has been around for a while:
Examples of such industries would be: