Editor’s note: We’ve seen big moves in stocks lately. The new coronavirus has sent investors panicking… then running back in relief as economic measures roll out. As Steve has noted, stocks likely haven’t hit bottom yet. But while you don’t want to “catch a falling knife,” now is a good time to be building your wish list of profitable, lifelong investments…
The idea that you ought to buy and hold stocks – even though you know a bear market is approaching or intensifying – will seem like nonsense to a lot of investors.
So don’t misunderstand me. You must be cautious in today’s wild market… using all the safety measures we recommend, such as position sizing, asset allocation, hedges, and trailing stops.
It means we’ll soon get the chance to pick up cheap shares of the market’s most profitable, most resilient companies.
And while you might not want to hear it… we’re offering this advice because it’s what we’d want you to tell us if our roles were reversed.
Today, I’ll review one key characteristic of stocks that we look for in good times – that becomes especially important in bad times…
Here’s a simple question: Do you think you could name any of the 20 best-performing stocks in the benchmark S&P 500 Index between 1957 and 2007?
Wharton economist Jeremy Siegel wanted to answer this question thoroughly. It’s not as easy to figure out as you might think. The composition of the S&P 500 changes frequently. Siegel had to go back and get the actual list of stocks from 1957… and then follow each one to see how much they paid out in dividends, spinoffs, mergers, and liquidations.
So… what were the 20 best-performing stocks over that 50-year period?
Almost without exception, these companies sell high-margin products in stable industries that are dominated by a handful of well-known brand names.
Look at the top 10 names on this list – all of which produced 15%-plus annual returns. Our bet is that most of you have a number of these companies’ products in your house right now.
Crane probably stands out as an exception, along with a couple of others. So what is it that Crane (a maker of high-margin industrial parts) has in common with these other companies?
It’s extraordinarily capital-efficient.
Because of the 165-year-old company’s excellent reputation, the unique, proprietary nature of its products, and the stable, long-term nature of its business, it doesn’t have to spend a fortune on advertising… or on building new manufacturing plants to come up with new products every few years.
This means that as sales grow, the company doesn’t need to reinvest more and more capital into its business. Over the past 10 years (2009 to 2019), Crane has earned gross profits of $10 billion… and spent just $478 million on capital investments.
That’s only 4.8% in expenses – a percentage that has remained stable during this period. And that means the company has more profits to distribute to shareholders. That’s the whole secret of capital efficiency.
One of the reasons we’ve found it’s safe to buy capital-efficient companies during bear markets is that they can support their share prices…
Longtime Stansberry readers know we’ve recommended shares of Berkshire Hathaway (BRK-B) in the past as a great bear market stock. That’s largely because we know Berkshire will begin to buy back its own stock when its valuation falls… for instance, in times of economic hardship.
Capital-efficient companies can do the same, because they’re producing so much cash. In fact, a great test of any capital-efficient company is whether it’s producing enough cash to buy back all its outstanding shares.
This test combines the stability of that company’s cash flows (which is necessary for a high credit rating and access to cheap capital) with its cash-earnings power and a low share price. These are the three most critical factors for a successful bear market investment.
And here’s another hallmark of capital-efficient companies: They almost always return more money to shareholders each year than they spend in capital investments. They wait to buy back stock (or make wise acquisitions) when prices are low.
How can you do the same? How do you know when the right time is to buy these stocks, which almost always trade at rich premiums to the average S&P 500 stock?
To find the most capital-efficient companies, we look for the following criteria:
- Companies that have reasonably large market capitalizations.
- Companies with high returns on assets.
- Companies that produce large amounts of free cash flow (“FCF”) in relation to the revenue they generate. FCF is the amount of cash left over after all operating expenses and business investments.
- Companies that consistently reward shareholders with dividends and stock repurchases.
- Companies that consistently grow their revenues, year after year.
During a bear market, you should focus on buying capital-efficient stocks with these five traits. We at Stansberry Research have analyzed, recommended, and respected many of them for – in some cases – years.
In short, the recent fall in stocks has been painful. But it could soon give us a chance to invest in the market’s top performers… the kind of stocks you want to buy and hold forever.
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Source: Daily Wealth