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Want Stocks With Good Long-Term Growth Potential? Then Focus on These Fundamental Principles

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Jeff Cuellar

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The stock market can be a scary place for beginner investors just starting their investment journey. Why? Because you’ll always have that one hot-shot investor who games the market like he’s playing a round of roulette at Marina Bay Sands (MBS) with somebody else’s money – except he’s not.

He’ll pick a “hot” stock from a new tech company and dump his entire life savings into it. And once that stock starts plummeting like a meteorite – well… you get the point.

It’s investors who aren’t disciplined enough to invest in long-term stocks that scare other investors once their savings implode.

But as long as you follow these fundamental principles when choosing long-term stocks for your portfolio, there’s a much higher likelihood you’re not going to be staring at a blank investment account when you eventually need the money:

 

Look at the Stock’s Dividend Consistency

What are dividends? Dividends are a share of the portion of a company’s earnings to its shareholders. Of course, the company determines the value each share will receive, which is called the dividend per share (DPS).

When you look at a stock’s dividend consistency, you want to evaluate the company’s ability to pay dividends that are:

  1. Consistent: The company provides dividends every year
  2. Stable: The company provides a stable DPS every year

Any company that lacks consistency and stability when it comes to providing dividends is red flag that points to possible financial problems.

A company with steady dividend growth over the last 5 to 10 years is definitely a good long-term stock choice to consider.

 

Look at the Stock’s Price-Earnings (P/E) Ratio

A stock’s Price-Earnings (P/E) ratio will show you whether a stock is either overvalued or undervalued. That’s pretty important considering that buying an overvalued stock can end up losing you money once the investor excitement wears off.

Here’s how to factor a stock’s P/E:

If Stock A is currently trading at $50 a share and the earnings over the last 12 months were $1.35 per share, the P/E ratio would be: Price ($50) / Earnings ($1.35) = 37.03 (which is pretty damn high!)

Here’s what the P/E ratio tells you:

  • A High P/E Ratio: Means other investors are willing to pay a greater amount for the stock’s earnings, which is a good sign the stock is overvalued.
  • A Low P/E Ratio: Means a stock is more likely to be a better value since the market situation is probably responsible for the undervaluation.

Finding the P/E ratio of a stock is good, but to maximise this fundamental principle, you must compare a stock’s P/E ratio to the stocks of other companies in the same industry. So if one stock has a P/E of 7 but the average P/E in the industry is 10, that’s definitely a good long-term stock choice for your portfolio.

 

Look at the Stock for Consistent Earnings

If there’s one overarching theme when it comes to choosing the right long-term stocks, it’s consistency. And that’s definitely something you want to keep an eye on when looking at a stock’s earnings.

One of the biggest obstacles most investors learn to overcome is the reality that earnings will rise and fall with the economy. But, if you want to see whether the stock has consistently performed, you’ll need to do your research and check out the company’s past earnings and projections over the last 5 to 10 years.

Yes, it’s tedious work, but it’s a great way to see whether the stock’s price has consistently met or exceeded its earnings projections – and if it has, it’s definitely a long-term stock worth considering.

 

Look at the Company’s Debt and Current Ratio

If you want to know more about a company’s financial health – check out its debt and current ratio. When you look at a company’s debt ratio, you’re measuring just how much of it is financed with debt – it’s not really that complicated, just divide the company’s total liabilities by its total assets.

You can find both on a company’s balance sheet or annual report.

What the debt ratio will tell you are two things:

  1. The company is experiencing financial issues
  2. The company is financing its expansion (check the annual report and see any mention of new factories, products, etc.)

The current ratio on the other hand will show you whether the company is financially able to meet its debt obligations. To get a company’s current ratio, just divide its current assets by its current liabilities.

So if the company’s current assets are $400 million and its current liabilities are $200 million, it has a current ratio of two – meaning it has enough liquidity to pay its liabilities two times over.

The higher the current ratio, the more likely you’ve got a good long-term stock on your hands.

Final Note: If you’re still new to the investing game, don’t forget to check out our article The 4 Biggest Investment Decisions Every Investor Should Never Forget. Also, check out our Investing Learning Center for some more great tips for investing beginners.

 

What are some strategies you use to pick a winning long-term stock choice? Share your strategies with us on Facebook! For even more useful information on everything personal finance, visit MoneySmart today!

 

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Jeff Cuellar

I'm known by many titles: copywriter, published author, literary connoisseur, ex- U.S. Army intelligence analyst, and Champion of Capua.