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There is a wealth of evidence that the simple route to stock market success is to 'buy and forget' - and let the wonder of compounding work its magic over time.
That approach has certainly worked in spades for legendary US investor Warren Buffett: by putting together a portfolio of high-quality companies that he ideally wants to hold for decades, he has delivered annual returns of around 20% over his investing career of 50 years or more.
Spotting businesses that will stand the test of time is a hard skill to master, however. It requires both a trained eye and an element of luck, particularly in an age when new technology can completely revolutionise a market almost overnight. Nevertheless, companies that possess certain attributes, such as a big brand, valuable intellectual property or recurring revenues, are well placed to fend off the threat of new competitors.
In this feature we highlight the key characteristics or qualities that fund managers look for in pursuit of long-term winners and name 10 shares tipped for success over the long term.
This consumer goods company was backed by two of the 11 fund managers Money Observer polled. Both Job Curtis, manager of the City of London investment trust, and Hugh Yarrow, co-manager of the Evenlode Income fund, named the maker of Dove soap, PG Tips and Marmite the single share they could least imagine selling.
Curtis says: "In my opinion, companies that are consistent generators of profits and cash, have strong balance sheets and operate in stable business sectors are best placed to be core portfolio holdings. An example of such a firm is Unilever (ULVR), which makes 57% of its revenue from home and personal care products through brands such as Dove and Domestos."
He adds: "The other 43% of its revenue comes from food and refreshment brands such as Knorr and Magnum. Unilever's brands are very valuable (and some have been around for decades), but they need regular investment in advertising, marketing and product innovation to maintain their value."
Curtis's view is echoed by Yarrow, who says Unilever's varied portfolio of household names gives the firm "strong pricing power and [maintains] high barriers against market entry by competitors".
He adds: "You could see that power at work when Unilever took on Tesco in the recent [postBrexit] Marmite pricing furore. Unilever's success means it also pays a steady dividend - currently of around 3.7% - which it is able to grow in both good times and bad. Furthermore, demand for Unilever's low-ticket goods tends to be solid, and has remained resilient through a wide range of economic conditions."
Veteran fund manager Paul Mumford, manager of the Cavendish Opportunities fund, has decades of experience in buying and selling shares. He specialises in scouring the market for small companies with bags of potential.
Mumford says the trick in finding a buy-and-hold share to tuck away for decades is to look for "a business that will provide consistent long-term growth in earnings and is engaged in low-risk activity". He explains: "It must serve an area of the market that will still be around for the next 50 years or more."
His pick is Alliance Pharma (APH), a relatively small AIM-listed company that acquires niche drugs from large pharmaceutical companies. "Often these products are too small to move the dial in a big pharma but able to generate useful profits for a company the size of Alliance," says Mumford.
He adds: "Most of these products have been on the market for several years and carry little risk, and sales can be boosted with a minimal amount of expenditure. There is no exposure to expensive research and development, while a wide product portfolio further reduces risk. In comparison, biotech companies can produce spectacular results, but they often fail to achieve the desired end result, while bigger players are disadvantaged by having to spend vast sums to replace drugs whose patents are due to expire."
Another investor that has plenty of experience under his belt in fishing for hidden gems at the bottom of the stockmarket is Miton's Gervais Williams, manager of the Diverse Income investment trust (DIVI) and Miton UK MicroCap investment trust (MINI).
Williams points out that since most businesses are cyclical, it is a worthy feat to have a long history of evergrowing dividend payments. Among the big blue-chip names in the FTSE 100 index (UKX), Royal Dutch Shell (RDSA) is arguably the most reliable, as the last time it took an axe to its payout was in 1945.
Williams' pick, however, is a less familiar name. A&J Mucklow (MKLW), listed in the FTSE All-Share index (ASX), is a property company that invests in industrial property in the Midlands. It has impressively kept the dividends flowing every year since it listed in 1962 - although in four of those years the dividend was only maintained, rather than increased.
Outlining the investment case for A&J Mucklow, Williams points out that over the past 30 years, a period of globalisation, demand for UK industrial property became patchy as many companies moved their manufacturing operations to lower-cost territories. But this trend has largely ceased now, and demand for industrial property is currently on the rise.
He adds: "As a result, Mucklow is currently seeing a sustained rise in its rental income that I believe will continue to fund further dividend growth for many years, although, of course, nothing is guaranteed."
Burford Capital (BUR), one of the largest listed stocks on the AIM market, provides financing for legal disputes, typically commercial legal cases in the US.
It is a "market leader" in its field, according to Margaret Lawson, who manages the SVM UK Growth fund. She says litigation is a hard market to crack, so investors are protected to a degree by high barriers to market entry.
She adds: "For a company's share to stick in a portfolio through good times and bad, an investment manager must have confidence in the firm's business model, management team and long-term market potential. That often favours companies operating in niches, sheltered from economic headwinds. Burford is a market leader in an expanding market. It is a litigation and legal funder with a strong track record, that has delivered high returns on invested capital."
She adds that Burford is well positioned to benefit from the fact that global businesses are operating in an increasingly litigious environment.
"Burford's services help free up cash that might need to be swallowed up in lengthy litigation. Burford's skill in screening legal cases for investment represents a barrier for new entrants. The firm is in a young industry and has the potential to grow for many years," says Lawson.
Mears, which listed in 1996, has become the leading social housing repairs and maintenance provider in the UK. This, and the fact that the company is the dominant player in a highly fragmented market that remains buoyant, is why Sue Round, manager of the EdenTree Amity UK fund, is backing the company as a long-term winner.
In addition, Round points out that "the current housing stock has aged" and that this should lead to increased demand for repair and maintenance services.
She adds: "It has a consistent win rate when bidding for contracts, which are often long-term; that combined with excellent operational discipline has led to stable margins and a growing order book, which currently stands at £3.5 billion."
She continues: "Management has built up a commercial reputation for delivering a high level of service. The company's business model has established a strong comparative advantage, leading to strong cash flow generation and a healthy order book, supported by a robust balance sheet."
One of the main attributes that gives a company an edge is its intellectual property, which could be, for example, a superior product or service that competitors cannot replicate. Electronics giant Renishaw (RSW) has this quality in its locker, which is why Anthony Cross, co-manager of the Liontrust UK Smaller Companies fund, has held shares in the company since 1998, when the fund was first launched.
Cross says: "Renishaw provides products designed to enhance precision and efficiency in areas such as medical diagnostics, machine calibration and neurosurgery. It has a rich store of intellectual property resulting from decades of accumulated investment in research and development, and it enjoys a high level of recurring business."
Cross points out that, as with any company, Renishaw is subject to macroeconomic conditions that are beyond its control. Nevertheless, he says, the company has 'a proven record of generating significant long-term secular growth through economic cycles', and as a result, Cross fully expects to still be holding Renishaw shares 20 years from now.
This AIM-listed company may not be a household name, but it has friends in high places. The firm translates patents for blue-chip multinational companies, and in doing so it helps protect its clients' intellectual property internationally.
Keith Ashworth-Lord, manager of the CFP SDL UK Buffettology fund, is a fan of the company. He says the firm is capital-light and has been a consistent dividend payer since floating in 2003.
He adds: "It is unique in that its 800 employees are dual-qualified. That is not something that can be replicated by others operating in this space, who are mainly patent attorneys, small family businesses or freelancers. In addition to being bilingual or multilingual, the firm's translators are industry specialists with in-depth knowledge of particular disciplines, such as pharmacology, life sciences, engineering and medicine."
When a product has made itself a mainstay in the kitchens of both Buckingham Palace and the White House, it is worth taking notice of. Rational makes commercial ovens, and according to James Thomson, manager of the Rathbone Global Opportunities fund, it is the best in its field. "It can cook different items on different trays at the same time, perfectly customised. A single Rational oven allows you to free up as much as 50% of the space in a kitchen, and you need significantly less staff."
In terms of risks, Thomson says that Rational shares never look cheap, while businesses such as Rational's will always be at the mercy of the financial health of their customers.
Some investors avoid airline stocks, reflecting the fact that a couple of bad apples in the industry have in the past destroyed investors' capital. Since the millenium, for example, three of the biggest US airlines - American (AAL), United (UAL) and Delta (DAL) - have filed for democracy.
But this does not mean the whole sector should be tarred with the same brush. In fact, as Alan Rowsell, manager of Standard Life Investments Global Smaller Companies fund, points out, those who ignore the sector risk missing out on gems. His 'buy forever' stock is Heico (HEI), a US company that makes spare parts for jet engines and other niche components for airplanes.
"It is a classic example of a smaller company that flies below the radar of most investors, yet it is vital to the airline industry and a market leader in what it does," he says.
The jet engine market is dominated by larger players such as Rolls-Royce (RR.) that make all their profit from selling expensive spare parts, adds Rowsell. By reverse-engineering such parts, Heico is able to manufacture alternative, cheaper versions, so airlines that use its products save money.
Rowsell adds: "I think Heico's business model is sustainable and has lots of runway in front of it."
Last but by no means least is Warren Buffett's company, Berkshire Hathaway (BRK.A), which has a portfolio jam-packed full of high-quality businesses. Some of his core holdings have been held for decades. American Express (AXP), for example, was first purchased in 1964. Other long-term favourites include Coca-Cola (KO) and Wells Fargo (WFC). Both stocks were purchased almost 30 years ago.
Giles Parkinson, manager of the Aviva Investors Global Equity Endurance fund, says the business has so many diverse revenue streams that it is unlikely ever to be knocked off its perch by a competitor, even when Buffett passes on the baton.
"Even without Buffett, I expect the business to be resilient. He has created a business with various strings to its bow rather than being the sole brain behind one particular product," says Parkinson.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise.The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
|COCA COLA CO||$45.72||0.02%|
|AMERICAN EXPRESS CO||$93.91||0.23%|
|UNITED CONTINENTAL HOLDINGS...||$58.51||0.53%|
|BERKSHIRE HATHAWAY INC CLASS A||$271,980.00||0.21%|
|WELLS FARGO & CO||$54.13||-0.05%|
|BURFORD CAPITAL LTD||1,138.00p||1.88%|
|MUCKLOW (A & J) GROUP||510.00p||0.00%|
|DIVERSE INCOME TRUST (THE) ...||100.50p||-0.99%|
|AMERICAN AIRLINES GROUP INC||$47.50||0.23%|
|FTSE ALL SHARE||£4,058.05||0.15%|
|DELTA AIR LINES INC||$49.48||-0.68%|
|ROYAL DUTCH SHELL||2,331.00p||-0.28%|
|ROLLS ROYCE HOLDINGS||897.00p||0.90%|
|MITON UK MICROCAP TRUST PLC...||61.88p||0.00%|
|All data 15min delayed as of: 18:53:10 20/11/17|
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