Eight-Point Guide for Picking Great Stocks

Our very survival depends on our ability to stay awake, to adjust to new ideas, to remain vigilant and to face the challenge of change.’

Martin Luther King Jr.

You won’t build a winning portfolio with just any old mix of stocks. Only the best businesses out there deserve your hard-earned money.

So before even being considered for any of the Guild’s portfolios, every potential investment must meet our strict list of eight criteria. No exceptions.

Here’s what they are…

#1. It must be a cash rich business.

A business’s finances are not so different from your own. You probably earn a certain amount of money each month from your job, and maybe some from investments.

Out of your income, you have to pay your expenses. The more cash left over, the better your financial position.

Businesses are no different. Before investing, you have to look for companies with a strong cash position — those left with high levels of cash after paying their expenses.

Companies with high cash flow ratios also tend to pay dividends. US discount retailer Wal-Mart, for example, has raised its dividend payments every year for 41 years. It not only paid — but increased — dividends through recessions, government shutdowns, wars, real estate busts and even during the GFC.

Now imagine you had a few companies like that tucked away, working for you in the background for your retirement. This is the power of a cash rich business. And is the kind of business we look for at the Guild.

#2. A great business will survive and prosper through any threats and challenges.

These can come in many different forms — new competitors in the market, technologiesmaking operations or products obsolete, shifts in the economy, or changes to legislation…to name a few.

History is full of companies who were at the top of their game but failed to adapt to changing environments. You do not want those in your portfolio.

Take Blackberry, also known as RIM, for example. Not all that long ago, throughout the corporate world, any smartphone was known as a ‘Blackberry’. But in time the compelling features of personal iPhones and Android devices were recognised by employees. Soon after, corporate IT departments made the switch to the new technologies.

Blackberry failed to adapt. Its first modern touchscreen phone wasn’t released until 2010 — three years after the iPhone came on the market. By then it had a huge deficit to make up. And it failed to do so.

It teaches us a valuable lesson…

Invest only in businesses that recognise the threats and challenges they face. Businesses with realistic and achievable plans in place, who respond and adapt.

#3. Before investing any of your money, always look for a quality management team.

While Blackberry floundered, Apple soared. Above all, it was Apple’s leadership that made it such a dominant force in the mobile phone market.

In the 1980s, under the management of co-founder Steve Jobs, Apple established itself as a dominant competitor in the personal computer market. Jobs left the business in 1985, but after a bleak outlook in 1997, Apple brought him back to lead the company.

Jobs applied his exceptional leadership skills to remind Apple to focus on its strengths — providing simplified, user-friendly products. It wasn’t long before the company returned to greatness, an industry leader in the mobile phone market, at Blackberry’s expense. Its shareholders did quite nicely too.

Only look at businesses with experienced management teams with a proven track record.

As an investor, you are trusting these people with your money. They must display quality decision making and leadership.

#4. Make sure the business you’re investing in has low or declining debt.

Of course, in business, a little debt isn’t always a bad thing. Sometimes loans are needed for growth, just like borrowing money to renovate your home. You’re taking on more debt, but you’re raising the value of your property — assuming you chose the right renovation projects.

But even if you’ve raised the value of your home, if you can’t meet the repayments, you’ll soon find yourself on mum’s couch.

It’s no different in business. While businesses with no, or low, debt are preferable, many businesses need to borrow money at times for new projects and expansions. But they must invest wisely, without taking on more than they can handle.

They should have a proven track record of doing so before you consider buying shares and lending them your money.

#5. Industry dominators with competitive advantages.

If you’re flying to Sydney, you’ll pass through Sydney Airport. It’s also a mandatory hub for many international travellers flying to and from other parts of Australia. That’s why 22 million people fly in and out of Sydney Airport each year. With just one major airport, you don’t have any choice.

This gives Sydney Airport a competitive advantage. They have a monopoly. And with the massive expense involved in building airports, it’s very difficult for competitors to enter the market.

You want to invest in companies that dominate their industry or offer a unique competitive advantage. You want to find the businesses that dominate with innovative products.

Invest in companies with established, well-respected brands that are likely have opportunities to grow their share of the market.

Read the rest of this article at Money Morning