The investors that have been able to amass vast fortunes over many years have generally done so by following a strict set of investment rules, refined over many years of learnt lessons. Warren Buffett has one, Peter Lynch is others, and the Motley Fool team has our own set of rules for recommending a top stock pick.
The following three elements of a successful company are not exclusive to any one investor but I have no doubt that Mr Buffett and Lynch use these rules (or similar) when deciding whether to invest in a company.
1. The company must be resilient
Many companies were forced into bankruptcy or have never really recovered from the GFC. The best companies therefore, as those that have successfully negotiated the hard times and come out on top.
Consider Woolworths Limited (ASX: WOW); the company has grown earnings and dividend per share in each of the last 10 years. Even during the GFC dividend per share rose by nearly 10% per year!
The opposite is true of National Australia Bank Ltd. (ASX: NAB), who's earnings per share is still below the 2008 high of 260 cents per share, while dividends have only recently increase to pre-GFC highs.
2. The company should produce plenty of free cashflow
If a company isn't producing free cashflow- ie its outgoings are higher than incomings, then it is potentially on a slippery slope towards too much debt or having to reduce dividends. Great companies like BHP Billiton Limited (ASX: BHP) and Veda Group Ltd (ASX: VED) produce plenty of free cashflow that can be used to invest in growth opportunities or increase payouts to shareholders.
3. The company's debt level should be manageable
Despite what uncle Bob may have told you over Christmas lunch, some debt can be healthy for both an individual and a company. Taking on debt can allow a company to expand in order to grow earnings or to fund certain purchases to benefit the business.
Investors should be careful to only invest in companies that have a strong history of implementing additions successfully. An example of this is Amcor Limited (ASX: AMC), which has a terrific history of consistent returns to shareholders while expanding.
