Buffett does not constantly check in on his securities. Instead, he lets them work for him by accruing the benefits of growth over time.
Jesse Livermore was one of the most successful stock traders of all time. While he did not practice true long-term investing, the quote above shows his adherence to the idea of letting winners compound.
Peter Lynch pioneered PEG investing. He managed the Magellan Fund at Fidelity between 1977 and 1990 and generated compound returns of 29.2% a year.
4 Step Long-Term Investing Strategy
The strategy long-term investors follow is straight-forward:
1. Identify companies with strong competitive advantages
2. Be sure these companies’ competitive advantages will last
3. Invest in these companies when trading at fair or better prices
4. Hold these for the long-run
This 3 step-process greatly reduces the field of stocks that investors have to choose from.
There are a few ‘shortcuts’ to quickly find businesses with strong and durable competitive advantages.
One place to find these stocks is the previously mentioned list of all 50 Dividend Aristocrat stocks.
Another place to find high quality businesses suitable for long-term investing is the Dividend Kings List. The Dividend Kings list is comprised exclusively of businesses with 50+ years of consecutive dividend increases. There are only 17 Dividend Kings.
Parts 1 and 2 of this strategy are typically satisfied by investing in Dividend Aristocrats or Dividend Kings. It is important to do our due diligence after finding an Aristocrat or King to verify the company is likely to keep its competitive advantage going forward.
Step 3 of this strategy is to invest in these businesses only when they are trading at fair or better prices.
To find if a company is trading at ‘fair or better prices’, a few financial ratios and metrics are important.
The first is the company’s price-to-earnings ratio.
If the company is trading below:
1. The market price-to-earnings ratio
2. Its peer’s price-to-earnings ratio
3. And its 10 year historical average price-to-earnings ratio
It is likely undervalued. These 3 relative price-to-earnings ratios will help to paint a picture of if a stock is ‘in favor’ or ‘out of favor’.
As a general rule, it’s best to buy great businesses at a discount – when they are out of favor.
You can see the current and long-term market average price-to-earnings ratio on Multpl.com.
Finviz provides peer price-to-earnings comparisons for free.
Value Line’s 1 page analysis sheets show long-term historical price-to-earnings ratios for individual stocks. If you are in the United States, ask your public library how to access Value Line for free.
Another good metric to look at for determining value is a company’s expected payback period.
Payback period is calculated using an expected growth rate and a stock’s current dividend yield. The higher the dividend yield and expected growth rate, the lower the payback period. The payback period is the number of years it will take an investment to pay you back. Obviously, the lower the payback period, the better.
