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The market’s giving us a bit of whiplash recently – but what else is new?
My editor told me earlier today that she made 108% on some Starbucks Corp. (SBUX) calls at the beginning of the year… only to have a similar trade plunge 66% immediately after.
It’s clear that what worked even a few weeks ago isn’t working now, and the urge to stick to the sidelines is strong.
However, as I’ve said on multiple occasions, I believe bear markets – and bearish trends – are a good thing.
Not only have market lows primed the way to higher highs, but when the situation appears bleak, know that the stocks you perhaps ordinarily couldn’t afford (or want more of) are now “on sale.”
Which means that now, more than ever, is the time to build your “Forever Stocks” portfolio…
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Buying Forever Stocks in the Worst of Times
I don’t think it’s too early to begin moving into stocks that you hold through good times and bad. Think of these investments as your core holdings. Treat these Forever Stocks as your “Elite 8” or “Top 10” — or whatever number you decide on.
In total, these stocks should represent about 25% to 35% of your total portfolio.
These are the stocks you hold through thick and thin, unless the rationale for owning them changes significantly or you decide to replace one of them with a different stock.
Obviously, these Forever Stocks will suffer during a bear market, but these losses are a small price to pay for big long-term gains.
Conventional wisdom says that market lows are the best time to buy stocks. Yet — thanks to our emotions — it’s also the hardest time.
As the late investing legend Sir John Templeton famously observed…
To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude … and pays the greatest reward.
So what type of security is a Forever Stock?
I’m talking about dominant, world-class businesses…
While there’s no set definition of a world-class business, I believe they share at least four critical traits:
- Forever Stocks possess an impregnable competitive advantage over their competitors — a “moat.”
- Their competitive advantage shows itself through rising revenue and cash flow. (Earnings should be rising as well. But accounting gimmickry can easily manipulate profits, so I generally ignore reported earnings and focus mostly on revenue and cash flow.)
- They use cash flow to enrich shareholders, through rising dividend payouts, share buybacks, astute acquisitions… or a combination of all three.
- They maintain a healthy balance sheet in order to preserve their financial flexibility and resilience.
In the rest of today’s issue, we’ll talk about that competitive “moat” I highlight in No. 1.
That moat could be a superior distribution network, like some railroad companies possess. Or it could be superior content, quality, or convenience — or some combination of these traits.
Factors like these create a moat around the corporate “castle”…
Protect the Castle
Amazon.com Inc. (AMZN)’s moat is its huge global distribution network, which allows it to sell goods at competitive prices and with superior convenience.
Most traditional retailers can’t compete against that. You know Amazon stock’s success story. If you invested $10,000 in it 10 years ago, you would be sitting on $96,130 today, even with the recent selling.
Nike Inc. (NKE)’s moat is its reputation for superior quality. During the last 20 years, Nike’s stock has delivered a whopping total return of 3,000% — more than 16 times the gains of the S&P 500 over the same stretch.
Like Amazon and Nike, most world-class businesses develop products or services that weave themselves into our daily lives.
When consumers develop loyalty to a brand, they resist switching and become less price-sensitive. Both of these tendencies help companies sustain long-term sales growth and healthy profit margins.
That’s good for shareholders.
In the early 1980s, I was a manager of the Hard Rock Cafe in West Hollywood. That place was hoppin’ all day, every day. From the moment we opened the doors for lunch until we shut down the bar after midnight, that restaurant was packed with customers.
On many days, that Hard Rock raked in more dollars from selling t-shirts, bomber jackets, and other merchandise than it did from selling hamburgers and milkshakes.
That’s the power of a strong brand — and a strong moat.
And it’s why owning Forever Stocks is so important.
On the date of publication, Eric Fry did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.