How to pick ‘forever’ stocks

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

At a wedding recently I got talking to a friendly elderly guest who, thankfully for me, was into investing. He bemoaned inflation over roast beef and waved away fund fees with his pavlova spoon. Pouring the coffee, he distilled a lengthy investment journey into a single point, “What you really want to do is find a good couple of companies, make sure they don’t do anything stupid, and do your best to hang onto them.”

That strategy, he told me, had allowed him to snap up an oil stock early in his career whose dividends now funded his retirement. Now, that’s compounding.

If you too want to be talking ‘forever’ stocks just before a brief boogie and long nap in a comfortable chair, what sort of traits should you be looking out for? Is it really that straightforward?

To kick off, it’s worth defining what we actually mean by forever stocks because, surely, that’s every stock we pick? Not quite. If you’re a value investor, you’re more likely to look for a company down on its luck, which you can buy ahead of a hopeful turnaround in the business, selling after that chapter is complete. For growth-hungry investors looking to tap into the next big global winner, it might be a case of selling if rampant revenue growth starts to calm down. It’s rare for newcomers to just keep extrapolating impressive expansion and growth forever.

Read more:

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By forever stocks, we’re talking about the companies whose business fundamentals just keep ticking along year after year, not shooting the lights out but not collapsing either. These are the companies long-term investors like for their relative predictability and proven ability to stay relevant in a changing world.

You might still want value and growth elements in there but here’s what to look out for if you think your portfolio could do with a bit more forever flavour:

1. Moats matter

We’ve spoken before about Warren Buffett’s penchant for companies with enough sectoral dominance to put off competitors; their moat. Having unassailable brand power, scale or product offerings is as much about defending the business as it is about growth. There will be rough patches so relying on business lines embedded into our daily lives can help soften the blow and keep margins intact.

2. We’ll never tire of saying it: compounding

Listed companies have an ability that no other asset class has - they can use earnings to pay out dividends, reinvest in themselves or a mixture of both. Making sure they put enough money back into the business to grow is essential, as is making sure this reinvested cash produces its own acceptable return. There are countless examples of companies making odd acquisitions, expanding into regions only to shut up shop soon after and generally making good money go bad. This is where you need to make sure management has a good track record of creating value and keep an eye on them to make sure they carry on doing it.

3. Boring is beautiful

Stable revenue streams, predictable earnings, proven management, good cash allocation - all positive attributes but it can feel a bit lemon and herb compared to the extra hot stocks on the Peri-ometer sometimes. Consistency is key here, though - we’re thinking in decades not years. It means the companies you look at probably won’t invent the newest technology but with that comes significantly less risk of volatile earnings.

4. Keep that free cash flowing

You might look at some high-growth stocks and wonder why they aren’t glued to all long-term investors’ radars - quite often the answer is cash. While gamechanging companies often plan to eventually produce profits down the line, a lot of investors want their businesses to produce cash now. When push comes to shove, the cash that’s left over after everything else has been paid for (bar the dividend) means a lot. This is the free cash flow that companies can use to fuel further growth and satisfy the market that top-line revenues are dropping through into profitable earnings.

5. Control the controllables

If the post-Covid era has shown us anything, it’s that there is an enormous amount of companies vulnerable to being shunted around by forces outside of their control. Inflation, interest rates, war, elections - these aren’t new phenomena and you should expect them to pop up at various points in your investment journey. It means you need to look for companies able to withstand the worst of the brunt by taking their destiny into their own hands. Are their products and services essential to how we live our lives or could you forgo them in an instant if your bills were to rise?

Read more:

When should I sell my stocks?

Why valuations matter, even in tech

Anchoring: when bias weighs on your returns

Think about sustainability too. Environmental, social and governance factors may be important to you ethically but consider their effect on the bottom line as well. Is a company likely to be fined for bad practice, taxed into oblivion in future or found out for mistreating its workforce? Ethical concerns aside, these could be real hurdles to the sustainability of earnings.

We’ve focused on the stocks so far but there’s a volatile element to investing in them that we need to address - us. We need to be patient and not jump from one idea to the next when it all feels a little monotonous. Be prepared to have the dullest point of view at the party - hares can have more exciting stories but tortoises can often sleep better at night.

When it comes to buying for the long term, pay close attention to the price you pay at the outset. Even great businesses can turn into bad investments if you pay too much for them. Valuations matter and can really help reveal good opportunities in consistent companies when they appear.

We’ll end with probably the two most important aspects to all of this:

1. Don’t fall in love with the stock. As the years go by, you might feel an affinity to a stock that has served you well and is firmly on the ‘forever’ list. Then comes new management, a bizarre acquisition or a change of strategy that has you scratching your head. If a change in direction starts to alter the very fabric of the business for the worse, it may be time to sell. The tricky part is recognising a strong sell from a short-term blip and that’s without factoring in our own attachment issues. Just make sure you don’t watch a useful stock become a laggard because you can’t let go.

2. Don’t just do something, sit there. Fundsmith CEO, Terry Smith, has a set of simple criteria for his investment process; find good companies, don’t overpay, do nothing. That last part is the one we can find the hardest. We are primed for action and often want to overtrade but, if you’ve found a forever stock, hitting buttons just to feel like you’re doing something can be the worst thing for you. Schedule annual check-ins if you like but don’t be rash - hopping between queues at the supermarket rarely makes the line go quicker and often means you end up behind where you started.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.