Picking great stocks can be a tough gig, and it is made even more difficult when the market itself is performing so strongly.
With the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) hovering just 0.6% below its six-year high, it's fair to say that not just any stock will manage to deliver market-beating performances in the future. In fact, there are many overvalued stocks which will likely drop in the coming years, let alone beat the market.
Before you buy your next share, check that the company meets these important criteria first:
1. Strong Cash Flow. Cash flows are one of the most important things to check when analysing a business. If it doesn't have a strong inflow of cash, it cannot expect to pay its expenses and will struggle for growth. You also need to ensure the business has a manageable level of debt and that it has the capacity to repay that debt.
It should also be noted that those companies with strong cash flows are much more likely to pay dividends!
2. Resilience. Markets boom and bust, new competitors will constantly pose as threats and technology can make products obsolete. You need to make sure your investments will survive (and maybe even prosper) through the toughest of conditions.
3. Moat. A business' "moat", or durable competitive advantage, is a definite sign of a solid investment prospect (provided that the shares are trading at a reasonable price). Coca-Cola Amatil Ltd (ASX: CCL) is a perfect example of a company with a strong moat.
4. Management. When you invest, you are entrusting a group of humans with your hard-earned money. Make sure their interests are aligned with your own.
5. Growth Prospects. When we invest, we are buying a portion of a company's earnings. We want those earnings to expand over time rather than decline or remain flat.
6. Price. It is important to remember that not all great businesses make great investments. I have said time and time again that Commonwealth Bank of Australia (ASX: CBA) is one of Australia's greatest businesses, but at today's price, it is not a good investment.
