Building a sturdy investment portfolio capable of compounding doesn't need to be an exhaustive exercise. Some will draw upon an endless list of complex, jargon-filled metrics to analyse ASX stocks.
Yet, the stock-picking process can be far more straightforward and intuitive by checking a handful of basic features of a business. I firmly believe in the Pareto Principle, which asserts that 80% of the output comes from 20% of the input. In the investing context, if you can focus on that critical 20%, deciding which shares to buy becomes far less cumbersome.
From my experience, here are six of the most influential criteria for deciding which stocks to buy.
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Selecting outstanding ASX stocks
1) Natural attraction
The first trait I look for in a company is an organic demand for its products or services — bonus points if its customers are fanatical. This is usually a good sign that what is being sold is valuable and desired by people.
Additionally, the more 'natural attraction' there is, the less artificial interest needs to be generated. This translates to reduced spend on marketing and advertising, leading to better margins for the company.
An example of this is Tesla Inc (NASDAQ: TSLA). With an almost cult-like following, the electric vehicle maker barely advertisers, yet still sells over a million cars.
2) Margin monster
I will usually look for ASX stocks touting high margins. This is partially related to the above point on organic demand but might also arise from competitive advantages.
Whether it be brand power, scale benefits, network effects, etc. A high margin is a marker of a moat being present. Moats — and their associated high margins — are wonderful for investors because they often provide above-average returns over the long run.
For instance, CAR Group Limited (ASX: CAR) — the owner of digital marketplace Carsales — routinely achieves net margins above 30%. This is arguably a byproduct of its market leadership and inherent network effect.
3) Fortified foundations
The next feature I look for in an ASX stock before I buy is a rock-solid base business.
I don't want to invest a large sum of money into a company that is 'still trying to figure things out'. In my eyes, this presents an enormous risk if it doesn't all come together as planned.
The legendary value investor, Benjamin Graham, coined the term 'margin of safety' in the 1930s. There is little in the way of a margin of safety when a company has yet to prove its core offering. And if history has shown anything, you don't need to invest in the most speculative pockets to achieve monumental returns.
4) Optionality
A valuable trait for an investment is optionality. A business with multiple avenues in its future can reduce the risk of stagnation and obsolescence.
Apple Inc (NASDAQ: AAPL) is a great example of a company that expanded upon its core business. For a long time, Apple solely made and sold computers. However, the skills and expertise housed within were translatable to other tech devices, which soon became the iPhone, the iPad, the Apple Watch, etc.
5) Alignment
The people behind an ASX stock is critical. A company is only as good as the people running it. So it goes without saying that its important those people are incentivised to make good decisions.
Share ownership among management and key personnel is a simple way to link the two. In contrast, a salary doesn't offer the same level of alignment with shareholders.
A CEO can collect a large pay packet regardless of their performance. Whereas, remuneration tied to the company's shares means there's a clear incentive to deliver shareholder returns. For this reason, I will usually scout out companies with high insider ownership.
6) Appealing price
It might be last on the list, but it's no less important than the rest. Paying a reasonable price for an investment is always a factor in buying shares. That doesn't mean necessarily turning my nose up at anything with a price-to-earnings (P/E) ratio above 30.
As the famed Warren Buffett has quipped, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." An investor can be much more lenient on the price for a slice of an exceptionally high-quality business.
On the flip side, there's almost no price cheap enough for a terrible company.
