Last Tuesday seems like a lifetime ago. But that was the day I sent a Smart Money report that opened with these two sentences: “Stock market routs are miserable events. They sow widespread financial pain and suffering … along with a heaping dose of anxiety.”
Over the following days, we discovered just how miserable these events can be, as the Dow Jones Industrial Average plummeted about 5,000 points and all the major averages dropped into an official bear market.
So, what now?
Most likely, the major averages have not yet reached their bear market lows. Based on probabilities, the stock market averages will drift even lower than they are today and will reach their ultimate lows a few weeks or months from now.
That said, the stock market is not one big monolithic creature. It is a market of stocks. Even if the S&P 500 does not bottom out immediately, many individual stocks will.
“Best of breed” stocks, in particular, tend to bottom out first, and then move higher while the rest of the market is languishing. And because we investors rarely get the opportunity to buy best-of-breed stocks on the cheap, we should be looking for the opportunity to do that — starting right now.
As I said a week ago:
“Stock market selloffs are the extreme events that create opportunity. They produce the panic selling and ‘washouts’ that usually offer great moments to make savvy long-term investments…
History tells us that moments like these are what buying opportunities are made of. So if you have the stomach for it, do a bit of buying over the next few weeks … while others are fearful.”
It’s now time to put this philosophy into practice.
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 the coronavirus from China-driven bear market we’ve just entered. 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? What belongs in your Elite 8?
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 report, we’ll talk about that competitive “moat” I highlight in No. 1. (We’ll discuss the other factors in future Smart Money articles).
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’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 all know Amazon stock’s success story.
Nike’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.
I’ll see you back here soon with more on why we pay more attention to revenue and cash flow than profits when it comes to identifying Forever Stocks.
On the date of publication, neither Eric Fry nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.
Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends… before they take off. In fact, Eric has recommended 41 different 1,000%+ stock market winners in his career. Plus, he beat 650 of the world’s most famous investors (including Bill Ackman and David Einhorn) in a contest. And today he’s revealing his next potential 1,000% winner for free, right here.