When it comes to investing in the stock market, there are hundreds of stocks out there to choose from. But while some of them struggle or even go bust, a rare few deliver outstanding returns to shareholders over the long term. These are the sort of stocks that can go up 10, 20, or even 100 times in a lifetime.
Very often, these stocks will stand out from the crowd early on. Yes, they might appear expensive based on their a price-to-earnings ratio, but eventually it will appear that they weren’t expensive at all. High quality stocks deserve rich valuations.
Here are three things winning stocks have in common.
Management aren’t clock-punchers
When we’re investing in a stock, we want to see the board aligned with shareholder interests. After all, that is why they are employed – to create value for shareholders.
Very often, the best companies have entrepreneurial management. This means that they aren’t just punching the clock and collecting a paycheque, and that they are motivated to do what it takes to make the company succeed.
When management are entrepreneurial, they’ll often buy large amounts of stock with their own hard-earned cash. That aligns their personal interests with the interests of investors.
Finding a company whose board is well-motivated to deliver and that has a lot of skin in the game is always worth researching. But just because management have skin in the game doesn’t mean it’s guaranteed to deliver.
The ROCE margin is high
Return on capital employed, or ROCE, is the company’s own interest rate. It measures the money that a company invests in itself, and the return it receives. The higher the ROCE margin, the faster a company can grow.
This is especially true if the capital requirements of the business are light and it doesn’t require significant amounts of capital expenditure for maintenance. This is in contrast to restaurants and bars, and heavy machinery that often needs refurbishing or replacing.
When maintenance capital expenditure is light, then cash generated from investing in the company can be re-invested to help the company grow even faster.
The business is profitable and converts a lot of its profits into cash
Many companies can appear to be highly profitable, yet they fail to convert much of that profit into tangible cold hard cash. Companies that struggle to convert their profits into cash aren’t high quality companies – ideally we want businesses that have close to or even more than 100% profit to cash conversion.
Companies that have motivated, entrepreneurial management along with a high ROCE margin, and that convert most – if not all – of their profits into cash have historically been excellent businesses to own. Keep a look out and you might just find one.
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Views expressed 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.