Thousands of companies are publicly traded, which can make investing somewhat like finding a “needle in a haystack.” According to finance professor Hendrik Bessembinder, the stock market's historical gains have come from just 4% of stocks traded. In other words, you need to find the “winners” if you want to have investing success. Nothing in investing is “fool-proof,” but here are three ingredients that some of history's biggest winners have.
1. Let it grow
According to research by Morgan Stanley, 74% of a stock's long-term (10 years or more) total returns are driven by revenue growth. It may seem obvious in hindsight, but the more a company grows, the more it will be worth.
Investors want to be looking for companies that can grow revenue consistently for a long time. History is filled with companies that went through short periods of growth but were eventually disrupted by competitors, failed to execute, or had the company's core business become obsolete.
E-commerce giant Amazon is one of the most lucrative stocks of all time, rising more than 100,000% since going public in the 1990s. But behind these stock returns is a business that has continually grown rapidly for many years.
In 2002, Amazon's net revenue was $5.26 billion, which grew 36% over the prior year. In 2020 Amazon posted $386 billion in sales, 38% growth year over year. Amazon has maintained strong growth despite the company growing larger, which is a key attribute of any winning stock.
2. It's about making money
After revenue growth, gross margin is high on the list of what drives stock returns. Many businesses grow, but if a company can't make money, it will eventually come back to haunt investors.
There are many reasons why a company's gross margins can be affected, including:
Pricing pressure from competitors
The company's revenue depends on commodity prices that fluctuate
The business doesn't do well during recessions
These factors can cause a business to struggle to make money, so finding companies with very high and consistent gross margins is advantageous for investors.
Tobacco giant Altria Group doesn't rapidly grow its revenues. Still, its gross margins are consistently above 60%, meaning that Altria has made money regardless of what's going on in the world around it. The company has paid a juicy dividend to investors and outperformed the S&P 500 for more than 50 years.
3. Find the ships with the best captains
This key ingredient isn't as measurable as revenue or gross margin, and that is a company's leadership. Many of the best stocks in history are founder-led by CEOs with vision and aggression to reshape or invent new market opportunities.
Would Tesla Motors be where it is today without Elon Musk? Would Apple be a multi-trillion-dollar company without the groundwork that the late Steve Jobs laid with the iPhone? The right CEO can maintain a company's competitive edge and grow the business by identifying new ways to expand.
Many company founders cash out once their business goes public, and a CEO without vision can watch competition turn a great company into an also-ran. Companies with driven founders who stick around to take the business to great heights are not common and should be cherished when they are found.
Put them all together
Our recipe for a winning investment is a consistently growing, high-margin business led by dynamic and driven leaders when you put it all together. You can use these criteria to dramatically narrow down the field from the thousands of stocks out there.
While these ingredients cannot guarantee success, they create a good starting point for doing the needed homework on potential winners. Build a diversified portfolio of companies that satisfy this list, and you might be pleased with the long-term results.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Justin Pope has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Apple, and Tesla. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.