In my previous article I highlighted three rules that great investors have followed to amass huge fortunes by investing in companies on the Australian or international sharemarkets. The first three rules were:

  1. The company must be resilient
  2. The company should produce plenty of free cashflow
  3. The company’s debt level should be manageable

Now, the next three are a little more difficult but are just as important to ensuring you also generate better-than-average returns.

  1. The company must represent good value

This is a tricky point to define, as each investor will likely put a slightly different fair value on a stock depending on the assumptions used. The point is however, that whatever value you put on a company, you should buy it for less and understand the risks in your valuation.

Large risks or incorrect assumptions can make a massive difference. Take Woolworths Limited (ASX: WOW) for example, not long ago many analysts had a fair value target of around $30 on the stock in assuming that margins would remain at all-time highs. With competition hotting up and margins falling rapidly the calculation changes significantly, beware!

  1. The company should consistently grow earnings

This can be difficult for companies that have recently listed, but investing in fast-growing companies at a reasonable price has led to massive gains over time. A couple of opportunities for the future are Bapcor Ltd (ASX: BAP) and Corporate Travel Management Ltd (ASX: CTD), which are starting to prove that they can consistently grow earnings both organically and via acquisitions.

  1. The company has to have a competitive advantage

Many investors will have heard this phrase hundreds of times. Companies that have a firmly entrenched industry position or possess infrastructure that would be near-impossible to replicate hold incredible long-term earnings potential. Two companies in this position that I believe would be terrific buys at the right price are Brambles Limited (ASX: BXB) and Qube Holdings Ltd (ASX: QUB). Logistics companies are built over generations, not just years, and these two companies have the assets and networks to fight off almost any competition.

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Motley Fool contributor Andrew Mudie has no position in any stocks mentioned. The Motley Fool Australia owns shares of Corporate Travel Management Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.