Trying to pick shares for your retirement portfolio that will outperform the market for 10, 20 or even 30 years is a very tricky task.
But if we focus on shares with the best long-term potential, this Herculean undertaking becomes a lot simpler.
There are three main ways of determining whether a share will outperform the market for years to come. These are investment methods that helped enrich the world’s most successful investor, Warren Buffett, supported by his inspiration, Benjamin Graham, the father of value investing.
A share you can retire on
First we look at the people running the business to see if they make good decisions, pay down debt to keep growth sustainable and how they use free cash flow.
Secondly, we look at the company’s ‘economic moat’. This means that we decide whether it has a sustainable competitive advantage over its rivals. How could the competition squeeze the company’s profits, or margins? Does it have significant intellectual property that no one else can make money from?
Lastly, we need to look at a company’s valuation. Benjamin Graham wrote in his seminal 1949 work The Intelligent Investor about the concept of ‘Mr Market’. Mr Market is willing to sell you shares, but at one moment they will be fairly priced, at another they will be undervalued, and at another they will over-optimistically high.
The trick for value investors is to bide their time and wait for the moment when shares in well-run, competitive, profitable businesses are undervalued. Patience is key.
Fantasy roleplaying game-maker Games Workshop (LSE:GAW) has a strong competitive advantage because it is the only one making its incredibly popular Warhammer. In essence, this is a tabletop war game with a medieval fantasy theme that simulates battles between armies of different races and factions. The first edition was released in 1983 and it is still wildly popular to this day.
I think Games Workshop is one of the best-run companies on the entire FTSE index. It has around £30m net cash and uses very little debt in its structure. The share price is up 1,075% in the last five years, and up 108% in the past 12 months.
It is certainly one of the very few recreational games companies to pay a dividend. CEO Kevin Rountree decided on this policy to distribute “truly surplus cash” to bring new investors to the table. Earnings per share of 202.9p in 2019 produced a dividend of 155p for investors.
No other toymaker can compete with Games Workshop because of the exclusivity of IP it holds with the Warhammer series, and this is extremely unlikely to change in the future, making it a solid hold for decades to come.
Finally to the valuation. Mr Market is in his super-optimistic stage, with the share price flying up to an all-time high, but the fundamentals of the business are sound and I say there is much more upside to come.
You’ll pay 29 times its past earnings for Games Workshop shares, but with a trading update for the first half of 2019 showing sales, profits and royalties “significantly ahead of the prior year“, the forward P/E ratio drops to more like 20 times earnings. If the price dips in the New Year, I would snap up the shares.
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Tom Rodgers owns shares in Games Workshop. 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.