How to Make a Winning Long-Term Stock Pick

Many investors are confused when it comes to the stock market; they have trouble figuring out which stocks are good long-term buys and which ones aren’t. To invest for the long term, not only do you have to look at certain indicators, but you also have to remain focused on your long-term goals, be disciplined, and understand your overall investment objectives.

In this article, we explain how to identify good long-term buys and what’s needed to find them.

Focus on the Fundamentals

There are many fundamental factors that analysts inspect to decide what stocks to buy are good long-term buys and which are not. These factors tell you whether the company is financially healthy and whether the price of the stock has been brought down to below its actual value, thus making it a good buy.

The following are several strategies you can use to determine a stock’s value.

Dividend Consistency

The consistency of a company’s ability to pay and raise its dividend shows that it has predictability in its earnings. It also shows that it’s financially stable enough to pay that dividend (from current or retained earnings). You’ll find many different opinions on how many years you should go back to look for this consistency—some say five years, others say as many as 20—but anywhere in this range will give you an idea of the dividend consistency.

Examine the P/E Ratio

The price/earnings ratio (P/E) ratio is one common tool used to determine whether a stock is overvalued or undervalued. It’s calculated by dividing the current price of the stock by the company’s earnings per share. The higher the P/E ratio, the more willing some investors are to pay for those earnings. However, a higher P/E ratio is also seen as a sign that the stock is overpriced and could be due for a pullback. A lower P/E ratio could indicate that the stock is an attractive value and that the markets have pushed shares below their actual value.

A practical way to determine whether a company is cheap relative to its industry or the markets is to compare its P/E ratio with the overall industry or market. For example, if the company has a P/E ratio of 10 while the industry has a P/E ratio of 14, this would indicate that the stock has an attractive valuation compared with the overall industry.

Watch for Fluctuating Earnings

The economy moves in cycles. Sometimes the economy is strong and earnings rise. Other times, the economy is slowing and earnings fall. One way to determine whether a stock is a good long-term buy is to evaluate its past earnings and future earnings projections. If the company has a consistent history of rising earnings over a period of many years, it could be a good long-term buy.

Also, look at what the company’s earnings projections are going forward. If they’re projected to remain strong, this could be a sign that the company may be a good long-term buy. Alternatively, if the company is cutting future earnings guidance, this could be a sign of earnings weakness, and you might want to stay away.

Avoid Value Traps

How do you know if a stock is a good long-term buy and not a value trap (the stock looks cheap but can head a lot lower)? To answer this question, you need to apply some common-sense principles, such as looking at the company’s debt ratio and current ratio.