What characteristics of a stock do you think makes it a great investment?
A short-term trader might mention terms such as momentum, volatility and an ascending triangle pattern. Value-orientated investors might discuss leadership, return on equity and intrinsic value.
We can't say definitively which characteristics are right or wrong as each investor's requirements are unique, but we can create a more decisive list by following this piece of Foolish advice: invest for the long-term.
As a long-term investor, our success and returns ultimately follow the fundamental performance of the businesses we invest in – a simple fact but one we shouldn't forget.
Therefore, to find great long-term investments, we need to know: what characteristics are typical of great businesses? Listed below are some of the important qualities I look for in a great business:
Strong free cash flow – cash is king and investors should look for a business that produces ample free cash flows once all investment and financing requirements of the company are considered.
Good prospects for growth – a business with competitive advantages over its rivals or which is operating in an industry with economic tailwinds, such as the telecommunications sector. Preferably, we'll find a business with both of these qualities.
Quality management – the leaders of the business often dictate its future direction and performance. A competent and trustworthy management team will run the company in the interests of its owners – the shareholders.
Low debt levels– when mismanaged, debt can destroy a business along with the wealth of shareholders. Great businesses usually require little or no debt because they have strong earnings and produce enough cash to fund future requirements.
Here are some examples of ASX-listed companies that fit the criteria:
Large Cap – REA Group Limited (ASX: REA) is a digital advertising business and best known for its property website, realestate.com.au. It also produces large amounts of free cash and remains debt free.
Mid Cap – Domino's Pizza Enterprises Ltd. (ASX: DMP) is revolutionising the traditional pizza store with ideas like GPS tracking for delivery drivers. The business has an exceptional management team focused on long-term growth and customer satisfaction – a winning combination for shareholders.
Small Cap – Altium (ASX: ALU) provides design software for printed circuit boards – an essential part of modern electronics. Altium produces solid free cash flows, has no debt and operates in an industry expected to grow as more electronic devices are produced globally.
Once you have found a great business, there is one final step for before you have a great investment – buying it at an attractive price. No matter how good the company is or its growth potential, paying too much is a quick way to reduce your returns.
At current market prices, REA Group and Altium are good ideas for further research and could be great investments. Domino's is a quality business but currently too expensive for my liking – any failure to execute its business plan in the future is likely to punish the stock price and our potential returns.
