I’ve heard it said that some of the best long-term stock investors achieve annualised returns of around 30% per year. But that’s going some. And I don’t think I’d be able to manage that year after year for decades.
But what about 10% a year? Even that’s a high target. But I think it’s possible if I choose shares with care, manage my risk, and work hard at the process of investing.
Aiming to capture the power of compounding
And a 10% annualised return is worth having. Starting with £20,000 and compounding it at the rate of 10% annually for 42 years would lead to a pot worth just over £1m. But I wouldn’t stop there. Adding £100 of new money every month along the way would boost the compounded pot to a value of just over £1.7m over the same 42-year period.
Those illustrations take no account of inflation. In reality, I’d likely increase my monthly contributions as my earnings increased over the years. And the eventual pot would could be larger, thus preserving the spending power despite the effects of inflation.
It’s true that achieving a 10% return on average every year will take hard work. But I think the efforts are worth the ‘sacrifice’. And for me, the process of investing is absorbing and fun, so that helps! However, we’ve seen with various stock market crashes over the years that there’s huge potential for setbacks along the way.
Nevertheless, over a period measured in decades, I’m optimistic businesses can thrive. But not all of them. So, I’m following the investment greats such as Warren Buffett. He’s known for investing in businesses with enduring competitive advantages and pricing power. And for me, the best way of finding great potential investments is to look at the financial indicators that indicate quality.
Hunting for quality at a fair price
For example, I’d want a business to has a consistent, high looking profit margin. And it would need a record of robust returns against equity and invested capital. But one of the indicators I like most is a long record of consistent annual rises in revenue, earnings cash flow, and shareholder dividends.
But that’s only the start. Having identified candidates for my portfolio, I’d read annual reports and news flowing from the company to try to get a good grasp of the business. It’s important to try to understand why the business has a competitive advantage and what its prospects look like for the next few years.
Yet quality considerations are only part of the puzzle. The next step is to target the stocks at opportune moments when the valuation makes sense of a long-term investment in the company. And it often takes down-days, bear markets, and short-term setbacks within a business to deliver an attractive valuation and thus a decent buying price for the stock.
On top of that, I’d aim to manage risks by selling stocks sometimes if my investment thesis alters because of a change in circumstance in the underlying business. Or I might sell simply because of finding a better opportunity in which to invest.
Meanwhile, uncertain times such as we have today may be a good time to look for potential enduring long-term stock investments.