Picking the best companies that you can buy and hold forever, without having to check-up on them constantly, is tough. But it’s not impossible.
Indeed, SABMiller (LSE: SAB), Unilever (LSE: ULVR) and Diageo (LSE: DGE) all possess the qualities of a successful long-term buy-and-forget investment. But what exactly are the qualities you need to look out for?
Learning from the best
Charlie Munger is Warren Buffett’s right-hand man at Berkshire Hathaway, and he has built a multi-billion dollar portfolio on the belief that quality is worth paying for.
Charlie Munger’s logic is simple. If you buy a good business with a great set of products, over time the returns generated from the business will stack up. As a result, even if you pay a high price for the business, you’ll still end up with fine results.
As I’ve mentioned before, key to Munger’s concept is a company’s return on equity — a telling and straightforward gauge for comparing the relative profitability levels of companies. If you can find a company with a stable ROE that’s higher than the market average, you’re on to a winner.
It is usually the case that the companies with the highest ROE figures have a competitive advantage, wide profit margins and a strong free cash flow. These are all highly desirable criteria and, over time, companies that tick these boxes should prove to be great investments.
Figures show that SAB’s ROE has averaged 13% per annum for the last ten years. Over the same period, the company has generated around $2bn per annum in free cash flow from operations while book value per share or shareholder equity has more than doubled. Net income has risen by 140% over the past decade and SAB’s dividend has surged by 209%.
And shareholders have really benefited from this growth. Since 2005 SAB’s shares have produced a total return of around 17% per annum. A £10,000 investment in SAB made during 2005 would be worth more than £50,000 today.
Of course, there’s no guarantee that this performance will continue. However, SAB’s leading position in the global beverage market, coupled with the company’s high ROE does point to further out-performance.
Unilever and Diageo both exhibit similar traits.
Diageo’s ROE has averaged around 30% per annum for the past ten years. Net income, shareholder equity, and the per-share dividend payout have all doubled over the same period. Moreover, Diageo’s total return comes in at 11.2% per annum for the past decade, which would have turned a £10,000 investment into £37,500.
Similarly, Unilever’s ROE has averaged 30% per annum since 2005. Additionally, over the same period shareholder equity has doubled. The company has turned £10,000 into more than £45,000 (including dividend reinvestment) over the past ten years.
These three companies all produce some of the world’s best-selling consumer products, including Smirnoff Vodka, Snow Beer (the world’s biggest beer brand) and Knorr, plus a variety of soups, sauces and dressings, the sales of which are easy to predict.
Therefore, the businesses are defensive by nature and the high returns on capital should be sustainable.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of 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.