There is nothing more focusing to a share investor’s mind than a 30 per cent plus pull back in share prices that we’ve experienced recently.
‘Black swan’ events like the coronavirus pandemic create tremendous uncertainty around our economic future and, in turn, share market selloffs.
Sadly, we do not have the benefit of being able to invest with hindsight and only with time will the true economic impacts become apparent.
We can’t predict the future, but we can say with a high degree of confidence which shares will survive and which will be the long-term growth winners.
Stock market crashes and periods of extreme fear offer good and sometimes a once-in-a-decade opportunity for investors who keep their cool, while everyone else is losing theirs.
We need to look through the market cycles and unforeseen events. History shows that those who retain a sense of optimism and understand good quality companies, operating in long-term growth trends will do more than survive, they will make you lots of money over time.
As a general rule of thumb, quality companies are not exposed to very cyclical sectors, like oil and gas, building materials, iron ore or steel. That is not to say some excellent companies operate in these sectors – but the historical evidence shows for long term wealth creation, these shares are not the best vehicle.
The cyclical nature of earnings is replicated in the share prices and as experienced investors know, picking the top or bottom of equity cycles is near impossible. Poor timing can be a loss-making experience.
Quality shares can be bought at any point in the economic cycle and deliver long-term growth and wealth creation.
These are the eight winning characteristics of quality long-term growth shares:
Identifiable moat: a moat is the summation of the competitive advantages good companies maintain and enhance. A strong competitive advantage is what allows a company to generate resilient earnings. Some of the features that constitute a strong moat are:
a. Strong and reliable supply changes that can withstand unexpected events and competition
b. Pricing power for the services or products offered
c. Technological investment and advantage
Good corporate culture and strong management: this can manifest in good corporate governance, gender equity, transparent stakeholder engagement and good corporate citizenship.
Sustainable investment: quality companies have the ability to invest between 20 to 25 per cent of their revenues in R&D and capital expenditure, also known as investing for the future.
A strong balance sheet and good cash flow: If ever there was a silver bullet for investors then this is it. Only during periods of disruption and economic pressure do the cracks start to appear for investors. Quality companies have strong balance sheets – that is, they are not saddled with too much debt and higher short-term refinancing costs. They have excellent cash flow generation to cover the debt servicing payments, even if revenues fall. Think of it as a safety margin.
The ability to internally disrupt: undeniably we are living in a time of great change. The long-term winners have the ability to successfully disrupt their businesses to ward off competitive pressures.
Excellent risk managers: like us, the share investor, good businesses are excellent at managing risks.
Dividend safety: the ability to maintain and grow the dividend payments over time.
Operating in strong secular markets: If the petrol combustion engine was the secular trend of the 20th century, then I can unreservedly say electric autonomous driverless vehicles and ridesharing is the new secular trend. The data era, internet of things, software as a service, 5G, neo banks, payment apps, healthcare and infrastructure are just some of the 21st century secular trends.
Generally speaking, companies that meet these eight characteristics are what I term the “sleep well at night” shares.
The share prices may move up and down with market volatility, but we can sleep safe knowing that the long-term growth prospects remain intact, despite any short-term noise.
We know this because until proven to the contrary the shares have a long-standing history of exhibiting robust earnings.
In Australia, we are lucky to have a number of excellent healthcare companies, including one of the nation’s largest companies in CSL. Others include Resmed, Cochlear, and even smaller companies like Promedicus and Nanoconics.
In the technology sector, Australia boasts some winners in Technology One, Altium, Appen and internet giants REA and Carsales.
These are but a few names. As much as we all like a share tip, the best way to make decisions for wealth creation is to invest in your knowledge. Proper planning and research goes a long way to improved decision making and improved wealth creation outcomes.
Disclosure: The author currently owns shares in all the companies listed above, except for Nanosonics.
Danielle Ecuyer has been involved in share investing in Australia and Internationally for over three decades, both professionally and personally. Her first book Shareplicity: A simple approach to share investing is out now.