Last week, I explained why I think “buy-and-hold” investing is a poor strategy for most investors most of the time.
In short, it requires strict emotional discipline to follow successfully over the long term. And it can expose you to significant market- and stock-specific risks.
However, I also told you there is one specific situation where I think a buy-and-hold strategy can work well for individual investors.
It involves what I like to call “forever stocks.” These are a select group of the very best, highest-quality businesses in the world that are likely to be around forever.
These stocks are ideally suited for a buy-and-hold strategy, because their high quality and steady nature help to minimize those three big drawbacks I explained last week.
If you’re interested in following this approach, there are three important ideas you need to keep in mind.
1. Pick Your Stocks Wisely
The first idea is also the most obvious: You need to choose the right stocks.
Owning only the very best businesses can give you the extra confidence you need to hold on through the inevitable ups and downs of buy-and-hold investing.
While there isn’t a definitive checklist for identifying a forever stock, these stocks generally share some common characteristics.
- Forever stocks tend to have a “moat.”
This is what’s known in the business world as a “durable competitive advantage.” Like a moat around a medieval castle, it provides a powerful defense against would-be competitors.
Moats can include a wide range of characteristics, including business size, brand recognition, physical or digital networks, rare property or assets, and intellectual property or patents.
In any case, a moat gives the company a significant advantage that can’t easily be duplicated by any other company in that industry.
- Forever stocks tend to have relatively thick profit margins.
This is a sign that the business is efficient at allocating capital and controlling its costs. Thicker margins mean the company can earn more profit for every dollar of sales than its competitors, and is also better positioned to weather economic or industry-specific slowdowns.
- Forever stocks tend to be “capital efficient.”
This just means they’re able to grow their business without having to spend a lot of money on capital expenditures like new factories, equipment, and trucks.
- Forever stocks tend to generate consistent free cash flow.
This is the actual cash a company makes after paying all of its operating expenses and capital expenditures. Unlike earnings, free cash flow cannot be easily manipulated with accounting tricks, making it a more reliable measure of business success.
- Forever stocks tend to generate consistent sales growth.
While rapid growth isn’t necessarily a requirement for a forever stock, the best companies are able to steadily grow their sales over the long term.
I shared several well-known companies that meet many of these criteria in a recent TradeSmith Daily.
They include Starbucks (SBUX), 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), Nike (NKE), Nvidia (NVDA), Procter & Gamble (PG), and Meta Platforms (FB).
2. Choose an Appropriate Investment Horizon
The second idea relates to how long you’re willing (or able) to invest.
Owning forever stocks can reduce the volatility you experience during broad-market corrections and economic downturns. But even the best companies aren’t completely immune to these events.
That makes buy-and-hold investing most suited for folks with a longer investment horizon, where there is plenty of time to recover from any short-term volatility.
As a result, I wouldn’t recommend following this approach with a significant percentage of your savings unless you have at least 10 years to invest before retirement. But 15 to 20 years would be even safer.
3. Don’t Put All Your Eggs in One Basket
Finally, the third idea has to do with diversification.
Again, choosing great companies can greatly reduce the company- and industry-specific risks I mentioned last week. But it can’t eliminate them completely.
While rare, even forever stocks can occasionally falter. And with a buy-and-hold approach, you can’t rely on trailing stop losses to protect you if they do.
That makes diversification critically important.
Generally, I would recommend spreading your buy-and-hold portfolio across 15 to 25 forever stocks.
This range is diversified enough to protect you from a significant decline in any individual company. Yet it’s still concentrated enough to produce market-beating returns over the long run.
Forever Stocks Aren’t Just for Buy-and-Hold Investors
Buying and holding forever stocks can be a fantastic and extremely profitable way to invest for the long term.
But it still requires more emotional discipline than the more “tactical” approach we typically recommend here at TradeSmith. So even with these benefits, this approach may not be a great strategy for every investor.
However, you don’t have to be a buy-and-hold investor to benefit from these stocks.
Forever stocks can make a great foundation in just about any investor’s portfolio, including those following the TradeSmith risk-management principles.
If you don’t already own some of these companies, I encourage you to add them to your watchlist today.