The stocks to hang on to for long-term investing

Woman drinking from a McDonalds cup © McDonalds
Buy the firms well protected from competition

When it comes to portfolio turnover, less is more. For most of us, frequent trading simply drives up costs and lowers returns, as a famous 2000 study by Brad Barber and Terrance Odean of the University of California demonstrated. So how can you build the perfect “buy-and-hold” portfolio? One option is to invest in only big blue-chip stocks, or a tracker fund. But what if you hope to beat the market in the long run?

US investor Philip Fisher, the author of Common Stocks and Uncommon Profits (1958), argued that if you could find companies that could grow consistently at a rapid rate over a long period, then you didn’t need to worry about short-term price fluctuations. For example, the value of semiconductor group Texas Instruments – one of Fisher’s tips – rose more than 1,500-fold from 1956 to 2000. Finding such stocks is not easy – but here are three questions to start with.

Does it have room to grow? A company can only grow rapidly for an extended period if its market is big enough to sustain such growth. Once a product reaches saturation point, growth will inevitably slow (as has happened to giants like McDonald’s and Walmart). Some companies get around this by moving into other markets – Amazon has moved from being an online book shop to selling other goods, providing cloud storage and now producing television.

Can it stay ahead of the competition? As US investor Warren Buffett argues, there’s no point in being in a fast-growing market if lots of rivals enter to force down prices and profit margins. Legal barriers can protect margins, but Fisher preferred firms that remained dominant by being the most efficient players in their sector, allowing them to undercut the competition. Research and development (R&D) is another way to stay ahead of the pack. A 2001 study by Louis Chan of the University of Illinois found that firms with high R&D intensity earn excess returns.

Is the management any good? Firstly, the management should be honest. Being prudent, by not taking on too much debt, also boosts the chances of longevity. The management also needs to have a long-term outlook, focusing on future challenges, rather than obsessing over the next quarter’s data.

Of course, even the best-run firms run out of steam (as happened to Motorola – once a Fisher pick – from the 1980s onward), so you do have to review your portfolio regularly. You will also have to invest time to build the portfolio. If you like the strategy, but don’t want to do the work, then the Finsbury Growth and Income Trust (LSE: FGT), run by Nick Train, has very low turnover and focuses on growth stocks.

Merryn

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