How to Spot and Trade Forever Stocks

By TradeSmith Editorial Staff

Listen to this post
With inflation threatening to get out of control, the Federal Reserve is letting Wall Street know that it is ready to start raising interest rates.

For the last two months, the market has been digesting this information.

The most recent market sell-off has investors wondering if they are in the right stocks. More importantly, are they in “forever stocks”? These are stocks you buy and add to with no intention of ever selling. Think of how Warren Buffett still holds the Coca-Cola stock he bought in 1988 for $1 billion (now worth north of $24 billion).

The key is to separate these stalwarts from trendy meme trades. One good area to examine is the technology sector, which has been a bloodbath.

Up-and-coming growth stocks like Affirm (AFRM), Roblox (RBLX), and Shopify (SHOP) are down more than 50%. Even more-established tech names like Netflix (NFLX) and Meta (FB) have received 35% haircuts from where they began the year.

As much as we like to showcase our “diamond hands,” those fun technology stock trades, it’s hard for any investor to experience massive drawdowns and not want to bail out of their position.

That’s where forever stocks come in.

These are companies that demonstrate consistent performance year after year.

Today, I’m going to show you three attributes to look for when building a forever stocks portfolio.

Does the Company Have a Moat?

A moat refers to a company’s competitive advantage. For example, Starbucks Coffee (SBUX) has phenomenal brand recognition and is widely recognized for delivering high-quality coffee.

A moat is sticky; it won’t be sensitive to price changes. If Starbucks were to increase its prices, it would be seen as a positive by investors because they know that their customers are unlikely to ditch them for another brand.

Furthermore, do you think Starbucks customers will stop buying its coffee because the Federal Reserve plans to hike rates this year? Unlikely.

Forever stocks like Starbucks are able to grow during any type of economic environment.

Here are a few more notable companies with moats: Disney (DIS), Alphabet (GOOGL), Kellogg (K), Lockheed Martin (LMT), Philip Morris (PM), Amazon (AMZN), Microsoft (MSFT), Walmart (WMT), Coca-Cola (KO), Hershey (HSY), McDonald’s (MCD), Apple (AAPL), Home Depot (HD), and Nike (NKE).

Sticking with best-of-breed companies, those with consistent growth in revenues and sales, is essential if you plan to hold forever.

Consistent Free Cash Flow

Free cash flow (FCF) is the cash a company has left after it takes the cash generated by its operations and subtracts capital expenditures. You don’t have to be a certified financial analyst to recognize that a business consistently bringing in positive free cash flow is what investors want.

Companies can and do manipulate income statements. But cash flows are the true arbiter of success and the key to stable dividends.

A lot of tech stocks got wrecked over the first two months of 2022 because they aren’t profitable.

This wasn’t a big deal before because money was cheap.

But now that interest rates are rising, it may become more difficult for some companies to raise money or take longer for them to pay off debt.

A company with strong free cash flow will be more durable during an economic downturn. With cash on hand, it can be more strategic during market downturns. For example, it can buy back shares if it believes its stock is underpriced. It can distribute a dividend or try to grow via mergers and acquisitions (M&A).

Notable companies with positive free cash flow include Apple, Microsoft, Alphabet, Tesla (TSLA), Berkshire Hathaway (BRK.A), Nvidia (NVDA), Visa (V), Walmart, and Procter & Gamble (P&G).

Consistent Sales Growth (Double Digits) Annually

If a business isn’t growing, then it’s dying. The best companies in the world continue to find pockets to grow their sales. For example, Apple, Costco (COST), Mastercard (MA), and Tesla have experienced sales growth of 10% or higher over the last five years.

Source: Statista

The graph above shows Apple’s revenue each year from 2004 to the present. With few exceptions, the company has managed double-digit growth every year, innovating new products and coming up with new sources of revenue.

Steady sales growth over an extended period of time is another way of showing investors that the company has a strong moat and is a leader in its sector.

The Best Way to Invest in Forever Stocks

Meta Platforms is one of the best companies in the world. It has seen its sales grow double digits over the last five years, it is one of the most well-known brands in the world, and it has a positive price-to-cash flow ratio.

However, despite all of the company’s positive characteristics, its shares have been clobbered so far this year. It makes you wonder if there is a better way to invest in forever stocks without having so much risk exposure.

Luckily, there is a very simple strategy that allows you to collect money simply for wanting to own a forever stock.

That’s right. This option strategy allows you to pick the price at which you are willing to buy the stock, and if it never drops at or below your price by a set date, then you keep all the money. You can then put the trade on again and repeat it as many times as you want.

The strategy is called a cash-secured put. And it offers a more tactical way to get long exposure on forever stocks.

For example, let’s say we like Meta, but we have concerns regarding its last earnings report and are worried about all the geopolitical news and economic headlines.

Instead of buying the stock outright, we decide to get strategic and sell some cash-secured puts.

The April 14, 2022, FB $190 puts are trading at $5.60.

Source: Thinkorswim by TD Ameritrade

We would make $560 for every contract we sold, as long as FB closes above $190 on the April 14 expiration date.

If it dips below the $190 level on the expiration date, we would be assigned 100 shares of stock at $190 per share — which is a lot better than the $207.79 per share it was trading at on Feb. 28. Plus you get to keep that $560.

This strategy is excellent not just during volatile periods in the market. It’s also exceptional during bull markets, when you recognize the trend is up but don’t want to chase up to buy shares.

The Bottom Line

Recent market uncertainty has investors questioning whether or not they have the right stocks in their portfolio.

The best businesses in the world have been through several economic upturns and downturns yet have managed a way to not only survive but grow and make their investors rich.

Today, we looked at three components of forever stocks and the best strategy to play them.

If you had to pick one of these metrics as the most important for your investments, which would it be and why?

Email me and let me know. While I can’t respond to each message individually, I promise to read them all.