Investing in winners! 3 ways I’d identify shares with huge potential

Here are three tips that I believe can help you find shares that will grow strongly in the future.

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.

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.

There’s much more to investing than the three steps I’m identifying in this article but the reason for outlining them is that they are three of the key steps I think will help separate the wheat from the chaff, giving you, the investor, the opportunity to do further research to uncover ‘winners’ that can grow in value.

Buy shares on modest valuations

With property companies and investment trusts, valuations are often easy to calculate. You can take the net asset value (NAV) and compare that to the share price to see whether a company is trading at a premium to what its assets are worth, or which one has its risks in terms of the share price being expensive (or at a discount), and which one has its upsides and downsides.

The upside is that if the share price is lower than the value of the company’s assets, it should eventually rise. But the downside is that investors may just not like the assets the company holds. For example, too many high street shops that are at risk of closing down can account for the discount. As always it’s vital to do your own research. 

For other listed companies, the price-to-earnings ratio will indicate the valuation of the business. The lower the figure the better, from a value point of view, but always assess whether a company is cheap because the business isn’t working or is in trouble. If it isn’t, but is cheap, then buying could be very rewarding.

Record of profitability and dividends

To invest in companies that are ‘winners’ you want to be able to see a track record of year-on-year rises in profitability, ideally in the form of operating profit or profit after tax, and a rising dividend. It’s important though to assess a company’s ability to keep paying a rising dividend so make sure to also check the dividend cover.

This can be calculated by dividing earnings per share by the dividend per share. Ideally, I’d suggest looking for cover that is greater than two, as this reduces the likelihood of a cut and increases the sustainability of the dividend. 

Companies that are profitable have shown there is demand for their product or service, that they have a handle on costs and so are less risky than, say, biotechs or little oil explorers that often need more cash from investors and potentially could never reach profitability.

Dividends are a way of working out if a company is profitable because generally speaking, they can only be paid out of profits or reserves.

Management quality with meaningful holdings

In smaller companies and family-owned businesses the value of shares management holds is an important indicator of the board’s confidence. Having ‘skin in the game’ aligns the interests of management with shareholders, which should benefit both parties.

In bigger companies, it’s much harder to build a large percentage of management ownership because the companies are worth billions. Nonetheless, even with FTSE 350 companies, ideally you want to see management actively buying shares rather than selling them or just being rewarded with them as bonuses.

I hope that these three simple tips will help you as an investor to find companies for your investment portfolio that have plenty of future potential.

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.

Andy Ross has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

3 of my top FTSE 250 stocks to consider buying before April

Buying undervalued UK shares can be a great way to generate long-term wealth. Here, Royston Wild reveals a handful on…

Read more »

Ice cube tray filled with ice cubes and three loose ice cubes against dark wood.
Investing Articles

Just released: our 3 top income-focused stocks to buy before April [PREMIUM PICKS]

Our goal here is to highlight some of our past recommendations that we think are of particular interest today, due…

Read more »

Investing Articles

Is this the best chance to buy cheap FTSE 100 shares in a generation?

I want to buy shares when they're cheap, and sell... never, just keep taking the dividends. And the FTSE 100…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Could NatWest shares be 2024’s number one buy for passive income?

For those of us looking to earn some long-term passive income, how does NatWest's 7% dividend yield sound? It sounds…

Read more »

Investing Articles

£12K in savings? Here’s how I could turn that into £13K annual passive income

This Fool explains how investing a lump sum can help her build a passive income stream to enjoy in her…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

Here’s why Rolls-Royce shares are now set to fly over the £4 mark

Once again, Rolls-Royce shares are crushing the FTSE 100. Should I add to my holding of this stock at the…

Read more »

Investing Articles

1 under the radar FTSE 100 AI stock investors should consider buying

Our writer explains why this FTSE 100 pick could be a shrewd investment with its established experience of using AI…

Read more »

Investing Articles

Does the beaten-down Diageo share price make it a no-brainer buy?

Harvey Jones spent years waiting for the Diageo share price to look like good value, before finally buying it in…

Read more »