What does a great company look like?

What sort of things should you be looking for when scrutinising a business?

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

What are the hallmarks of a great company? It’s a deceptively simple question, the answer to which is likely to depend on the investment strategy of the person it’s put to. Nevertheless, there are some things I think we, as Foolish investors, would all agree are desirable.

Defining ‘greatness’

The first quality investors should have on their list is a company’s ability to provide a product or service that its customers can’t do without or are willing to pay more for even if cheaper alternatives exist. For instance, the user-friendliness of its devices and sensitivity to offering consumers what they want has propelled Apple to the very top of the tree in terms of market capitalisation. Despite recently scoring something of an own goal through its very public spat with Tesco, Unilever would be another example thanks its massive portfolio of sticky brands that customers desire.

A second characteristic could be a company’s potential to grow to a very large size. Here, in-demand premium mixer producer, Fevertree would be a relevant case study. Since listing two years ago, shares have shot up by over 600% and, if analyst estimations prove accurate, there could be further upside left to come. This is why it can pay to look for opportunities further down the market spectrum. By recognising their potential early on, investors can make serious amounts of money.

Other things to look out for are companies that are able to achieve high operating margins and invest capital at a high rate of return. Those that can do so consistently should see earnings grow many times over which, in turn, should drive the share price higher. British engineer, Victrex ticks both of these boxes, in my opinion.

One final characteristic of a great company is its potential to endure for decades. This is one of the reasons why, in addition to chasing pharmaceuticals and utilities, many long-term investors have piled their cash into Sirius Minerals. Since its planned polyhalite mine in North Yorkshire will have an estimated life of 100 years, this could be one share that keeps on giving. 

Does price matter?

At this point, however, we encounter a problem. Even when they do find a company that satisfies all of the points above, some investors may be disinclined to snap up the shares because they’re seen as ‘expensive’ on traditional measures. They might argue that Fevertree’s price-to-earnings (P/E) ratio of around 50 or even Unilever’s P/E of 20 are just too high.

I think this is a mistake. As Warren Buffett said: “It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price.” In other words, basing investment decisions more on the price we’re being asked to pay and less on the quality of the company is dangerous, particularly as many businesses trade on temptingly cheap valuations for a reason.

What’s more essential, in my view, is recognising the fact that a great company can become distinctly average over a relatively short time if the story changes. This is why investors need to keep an ear out for any stock-specific news relating to companies they own and resist falling in love with a particular share. If the reasons for investing no longer apply, it’s time to move on.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »