This week we made a webinar presentation, to clients and potential clients, on the topic “How to Pick a Stock.” Over the past 30 years we have made this presentation or variations thereof, dozens and dozens of times. The main points do not change. What made a good stock 20 years ago still makes a good stock today. In our presentation, in fact, we typically include old stock charts just to make this point.
For example, we like companies with no debt and lots of cash. In a presentation 14 years ago we used Priceline (PCLN on NASDAQ) as an example of such a stock. It had no debt and excess cash at the time. In our historical presentation we highlighted how a strong balance sheet is important to a stock. PCLN stock was then in the $8 per share range. Well, today, the company has a bit of net debt, but not much, and cash flow is very strong. The balance sheet can certainly be considered in good shape. And the price today: $1,527 per share.
With that lead up, let's look at five things that might make a good stock ‘great', with all notes pulled from our recent presentation.
Good company management should own stock, not options
In every presentation we stress how important it is that management own stock in their own company. Not options. Stock. Basically, if a management team ‘screws things up', you want their net worth to take a serious hit along with you, the shareholder. Companies such as Savaria (SIS on the TSX) or Exco (XTC on the TSX) have very high insider ownership positions and may be worth a further look.
Good companies should not issue stock very often, if ever
We always check how the share count of a company has grown over a period of 10 years or more. For example, the share count of Home Capital (HCG on TSX) has moved from 68.3 million shares in 2006 to 64.5 million today, an actual decrease in the share count. The share count of Constellation Software (CSU on TSX) has been exactly the same, 21.2 million, for 10 years. Meanwhile, Westport (WPRT on TSX) has seen its share count go from 21.3 million in 2006 to 109.4 million today, and the number of shares at Katanga (KAT on TSX) has gone from 98.1 million to 1.9 during the same time frame. Guess which stocks were better performers during the past decade
Good companies should stay profitable in recessions
Now, we know that not all companies can maintain profitability during rough economic times. But, if they can, it certainly reduces your overall risks in owning those companies throughout a full business cycle. So, for example, if we look at Canadian Western Bank (CWB on TSX), which continued to stay very profitable in 2008 and 2009, in the midst of a worldwide financial crisis, or Alimentation Couche-Tard, which increased per share earnings in 2008 and 2009 (and every year since as well) then we know they might be “good” companies.
Good companies don't make excuses for mistakes
This is more of a general guideline, but if a company whose shares you own is continually coming up with excuses — such as the weather, or customer “push backs”, or whatever — then further investigation is warranted. A great company understands that business conditions change. They try to adapt, and, at least, don't try to blame others for their own problems. This is largely subjective, but if you own stock in a company that is underperforming, and all you hear are “excuses” and how things will “get better” then it might be time to start looking for another investment.
Good companies need to keep innovating, or buying competitors
Another item we always look at when researching companies is how much they spend on research, and what acquisitions they have made. Some companies (the aforementioned Priceline, as well as Google, Intel and Facebook) are expert at buying out competitors before they become a real threat. This ensures high market share but also, importantly, limits price competition. Other companies prefer to invest in developing new products, and this is a fine strategy too, so one needs to see how research spending has gone over the years. The key here of course is that spending must, eventually, translate into new sales and profits. Sometimes this can take years, which is another reason to be a long-term investor and not just a trader.
You really need to own one or two “great” stocks in your investment career to do well. Remember, a stock can only decline 100 per cent, but a great stock can go up 1,000 per cent, or more. The math works in your favour: thus, it is well worth it to do some homework before you buy.