Here’s a seemingly simple question: What’s the best way to attain long term investing success in the share market? In my opinion, the most truthful answer one can give is that there’s no best way. In investing, there are simply many roads that lead to Rome. My colleague Chin Hui Leong had recently shared how one might make great long-term investments through finding great business leaders or through finding companies that make products which are used by millions (or even billions) on a daily basis. The three keys to success I’d like to add on…
Here’s a seemingly simple question: What’s the best way to attain long term investing success in the share market? In my opinion, the most truthful answer one can give is that there’s no best way. In investing, there are simply many roads that lead to Rome.
My colleague Chin Hui Leong had recently shared how one might make great long-term investments through finding great business leaders or through finding companies that make products which are used by millions (or even billions) on a daily basis.
The three keys to success
I’d like to add on to that by providing three qualities in a company through which an investor might be able to find long-term winners. They are wonderfully described by my American colleague Asit Sharma in his article titled “How to Buy Stocks for Long-Term Appreciation.”
The first quality is strong cash flow from operations. This is him elaborating on the point:
“Creating powerful operating cash flow is a common trait among successful publicly traded companies with long records of market-beating results. Ample cash flow quarter after quarter implies revenue and margins that can cover the costs of production or services. Excess cash flows can be used for capital expenditures (e.g., equipment, land, buildings, technology, etc.), the paying-down or refinancing of debt, or shareholder-friendly initiatives like dividend payments and share repurchases.”
Asit then goes on to explain about the importance of the second quality – revenue growth:
“Rising revenue shows that a company has the ability to stay ahead of cost and labor inflation, and when it’s sustained over a number of years, it indicates that an organization’s products or services enjoy enduring demand. Of course, there will always be early-stage companies worth an investment even if revenue growth lies some years down the road — in industries such as biotechnology, for example. But at some point, a promise of revenue should convert to revenue, and over time, sales must increase.”
And then, he rounds it up with a discussion of net income growth, the third quality a company must possess:
“While it’s important to understand various measures of profit, from “gross margin” to operating income” to “earnings per share,” the importance of consistently increasing net income over time cannot be overlooked. That’s because net income measures profit after every conceivable expense has been considered, from the cost of goods sold to administrative expenses to taxes. Over time, a company worth your investment dollars should be able to produce measurable increases in net income.”
So is that all? Turns out, it’s also vitally important that all three must be taken into consideration together. As Asit describes:
“The point in taking all three indicators together is that in isolation, each can mislead you about a company’s overall prospects. For example, some companies generate strong cash flow with relatively little profit or revenue growth. Others may be adept at maximizing net income but inept at making wise investment choices or handling their working capital, leading to poor cash flow. Finally, a few brave corporations opt to try to grow market share above all else, and even with handsome revenue increases and superior cash flow, profits can be scarce.”
So with the three qualities in mind, let’s put theory into practice here in Singapore’s share market.
Putting it all together
Blumont Group Ltd (SGX: A33) was part of an infamous trio of shares which collapsed by more than 90% in price last October in a matter of days. Just prior to its crash, Blumont had risen by close to 4,000% within a year. That’s a spectacular return for anyone who managed to earn it but the thing is; Asit’s framework would have made it clear how unsustainable the whole situation was.
From the chart above (which covers the start of 2010 till the end of September 2013), it’s easy to observe how Blumont’s incredible rise in share price had not been accompanied by commensurate growth in revenue and net income.
We can contrast Blumont with Raffles Medical Group Ltd. (SGX: R01). Between January 2010 and September 2013, the healthcare services provider had grown by 117% in share price, but that was accompanied by roughly similar increases in its net income, revenue, and operating cash flow.
Since the end of September 2013, Raffles Medical Group’s shares have gone on to gain another 27% to its closing price of S$4.00 per share yesterday. In contrast, the Straits Times Index (SGX: ^STI) has gained just 5% to 3,324 points in the same period. And coming back to Blumont Group, its shares are now languishing at S$0.041 each – that’s a far cry from the price of S$2.45 it was at back in 30 September 2013.
Foolish Bottom Line
All told, Asit’s framework is a great reminder that long-term winners in the share market come about when there are shares with long-term business success.
But before you go out thinking you’ve found a sure-fire way way to pick winners, bear in mind that it’s also incredibly important that you pair the study of the trio of indicators with a thorough investigation of the qualitative aspects of a company’s businesses and industries. Only then can you truly maximise your chances of finding long-term winners.
To learn more about long-term investing and to keep up to date on the latest financial and stock news, sign up now for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock Singapore. Written by David Kuo, Take Stock Singapore tells you exactly what's happening in today's markets, and shows how you can grow your wealth in the years ahead. Also, like us on Facebook to follow our latest hot articles.
The Motley Fool's purpose is to help the world invest, better.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Raffles Medical Group.