In the search for the best long-term stocks, your typical supercharged growth stock may act like that fleet-footed hare in the famous Aesop fable. It has soaring earnings, big-time sales growth. The stock can break out with fury and surge to new highs and gains of 50%, 100% or even 200% in just a few months.
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Meantime, a true long-term stock winner may move like Aesop’s slow and steady tortoise — at least on a chart.
Given enough time, the best long-term stocks can outperform even the quickest hares. Even better? While sometimes a bit boring, they can deliver a steady ride to life-changing profits.
In the quest to find the best long-term stocks, investors might do well to consider a blended approach of two great investors: Warren Buffett and William J. O’Neil.
Buffett uses the classic buy-and-hold strategy. Find great long-term investments and hold them for years at a time. Sometimes forever. Bill O’Neil, the founder of Investor’s Business Daily, uses his CAN SLIM method. It entails actively trading high-growth stocks over weeks and months, rather than Buffett’s years-to-decades style.
Blending the two investing strategies led Investor’s Business Daily to create IBD Long-Term Leaders (LTL), a list of some of the best long-term stocks to buy and watch right now, based on factors including earnings stability as well as solid growth and price performance.
This approach addresses an issue raised by many investors: They love growth stocks, but don’t have the time to trade on a daily or weekly basis.
Best Long-Term Stocks: Domino’s Pizza Vs. Apple
When people think of great long-term investments, inevitably companies such as the FAANG megacap techs will come up.
But what about Domino’s Pizza (DPZ), which until the first quarter of 2020 had been a mainstay in IBD’s LTL list? Fast and convenient pizza delivery, but can fast food really compete with an Apple Watch?
Domino’s Pizza is the largest pizza company in the world. Starting in 1960 with just one store it now has 17,000 stores worldwide. Since the start of 2009, AAPL stock is up 5,700% but DPZ stock is up over 12,800%. The move for Domino’s came in classic tortoise fashion — slow and steady won the race.
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What Does A Classic Long-Term Stock Look Like?
When viewed on a monthly chart, the best long-term stocks all have the same look and feel. Focusing on the relative strength line, the steady outperformance vs. the benchmark S&P 500 jumps out. The line moves up as a stock outperforms the market index and turns down when it underperforms. Concentrate on the longer trend of this line.
While nothing goes straight up, imagine a very long-term moving average of the RS line. It’s rare for the best long-term stocks to violate this moving average line for more than a couple months. When a stock starts living below this line, then the character is starting to change. That’s a signal it might need to be trimmed or completely sold.
Using the RS line allows you to see how the very best long-term stocks tend to hold up better than other growth stocks during intermediate corrections and shallow bear markets. As IBD Long-Term Leaders consolidate during corrections, their RS lines tend to hold above their trend lines since they typically decline less than other leading growth stocks.
Switching to a daily or weekly chart view highlights the stocks’ lower volatility. Contrast a Long-Term Leader with a typical high-growth stock that you may find in the IBD 50. You’ll notice how the long-term investment is clearly the tortoise vs. the IBD 50 hares. This doesn’t mean they don’t have bad days. You can see 20%-30% deep bases. They just tend to be on the milder side relative to the stock market.
The standards set for the Long-Term Leaders list are based on analysis of the best long-term stocks as they began their periods of significant outperformance. The analysis showed the stocks had similarities in their fundamentals, technicals and sponsorship.
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Core Fundamentals Of The Best Long-Term Stocks
The most common fundamental characteristic is that the best long-term stocks have very stable earnings coupled with mild to medium annual earnings growth rates. Both IBD’s proprietary Earnings Stability Rating and stocks’ three-year annual growth rate can be found on the IBD Long-Term Leaders page. The data is also available for all stocks on MarketSmith weekly charts.
The Earnings Stability Rating ranges from 1 to 99. A lower number is better. First, earnings per share are plotted on a log graph over both three-year and five-year time frames. Then a line is drawn through the values to see how smooth they are. If the data appears random and jagged, the stock will have a high number. If all the EPS figures are perfectly on the line, it will have a Stability Rating of 1. Most Long-Term Leaders will have Stability Ratings less than 10.
Besides stable earnings, the leaders tend to have three- to five-year earnings growth rates from the low double digits to around 30%.
The rare stocks that possess very stable 50%-plus EPS growth rates tend to be monster movers. Mixing super-explosive growth rates with stable earnings, however, still makes for high price volatility. You’ll find these special stocks in the IBD 50 list and the MarketSmith Growth 250. Although you certainly may want to trade these stocks, their high volatility will keep them out of the Long-Term Leaders list.
While not mandatory, the best long-term stocks also have some if not all of the following: strong annual EPS estimates, modest but very stable sales growth rates, a history of meeting or exceeding quarterly EPS estimates, high annual ROE, low debt, strong margins and high EPS, SMR and Composite Ratings.
Nearly all Long-Term Leaders have very high-quality sponsorship, or share ownership by leading mutual funds. These stocks tend to be held by the very best-performing funds. These funds tend to hold their best stocks for years at a time, supporting them at key points along the way. This quality and stable sponsorship contributes to the stocks’ lower price volatility.
The Technicals Of A Best Long-Term Stock
The perfect Long-Term Leader will nearly put you to sleep watching it on a daily chart. The moves tend to be a little smaller, both up and down, than the typical growth stock.
Even looking at a weekly chart shouldn’t raise your heart rate. You’ll have a few weeks up then a week or two down, then start all over. Occasionally, there will be four or five weeks up in a row followed by a couple down.
The beauty comes from the monthly chart. All those tiny moves slowly outperforming the general stock market make for some amazingly long and steady uptrends.
Think of that tortoise with a big smile. With daily charts you might use 21-, 50- and 200-day averages to judge the stock’s trend. For weekly charts you could use 10- and 40-week averages. But for Long-Term Leader monthly charts, the focus should be on an uptrending 24-month average. A 12-month average can also be helpful.
Trading A Long-Term Leader Is About The Sitting
The goal with the best long-term stocks is not to trade them actively, but simply to hold them. The Long-Term Leaders provide a list of stocks that you might sit with for months or years until their character changes.
Buying can be as simple as the common methods of buying at standard base breakouts. Of course, you can also buy at a three-weeks-tight or pullbacks to the 10-week line.
The goal is to buy just once. Adding to your winning positions, also called pyramiding, should be done sparingly. Use small buys to add, and only after the original position shows a significant gain and has been held for several months. The reason is to keep a low cost basis. That will let you sit with a profit while the stock is going sideways or building a base.
Another way to get a low cost basis is to buy the stock at logical areas while the market is going through intermediate corrections. Many times, while the general market is weak, there may be a rotation into “quality growth” companies, like Long-Term Leaders.
These stocks may offer some alternative entry points as the stock recovers from a sell-off in a weak market. You wouldn’t buy weakness in the stock. Rather, the smart move would be to buy as the stock moves back up with an improving relative strength line confirming the move. A regular Long-Term Leaders column highlights when these alternative entries present themselves.
When To Sell A Long-Term Leader
Within CAN SLIM or any other style of investing, buying is the easy part. Selling is the hard part. Typically, selling a long-term leader will be based on a defensive sell signal. This means you will never be selling near the top, but on the way down.
One sell signal will be based on fundamentals. This is contrary to everything else in CAN SLIM, where buys typically are made based on both technicals and fundamentals and sells are based solely on technicals. This is because the technical price and volume clues tend to lead the fundamentals rolling over by several quarters.
With Long-Term Leaders, look for clues that they no longer meet your strict fundamental criteria. A good example would be a solid earnings stability becoming more erratic. This would cause the stability rating to increase past the upper limit of 10. Or if the earnings estimates dropped off to a level that suggested too much slowing. Or the company starts missing earnings estimates on a consistent basis.
Most selling, however, will still be based on technical price and volume action. Given the nature of the best long-term stocks, most selling will be defensive in nature. Watch for a character change, from slow and steady outperformance to underperformance.
The easiest way to see this is with the relative strength line on a monthly chart. Look at the general long-term trend of this line. If it starts to change character or roll over, this is a sign that Easy Street is coming to an end and danger may be at your door.
Remember a key characteristic of a quality long-term leader is its ability to outperform in a steady fashion. If the slow and steady profits disappear, it’s time to start selling.
If it helps, visualize a long-term moving average of the RS Line. You want it to stay above this imaginary line. A quick break and recovery is OK, but living below it is not.
More Sell Signals For Long-Term Stocks
Another sell signal is the stock coming well off its highs. Most bases along the move will have a depth of just 10% to 20%. Once the stock starts dropping 25% or more, danger could be around the corner.
As with most selling, it doesn’t have to be an all-or-none decision. As the stock falls 20% from its highs, a 5% position can become a 4% position. If it falls to 25% off highs, possibly a 2.5% position. Flexibility is key. If you keep the entire position as it’s falling, it’s easy to capitulate at the absolute bottom. The pressure becomes too great. Think of your position as a balloon. Letting a little air out incrementally keeps it from popping.
Bill O’Neil has always advised investors to cut losses quickly and let profits run. A Long-Term Leader should be a great stock. But if you are down more than 7% to 8% on the stock position, from a money management standpoint, you must cut it. You don’t want to get into the habit of having double-digit losses. It’s too easy to get into a deep hole.
What Is The IBD Long-Term Leaders Portfolio?
The IBD Long-Term Leaders Portfolio is a list of roughly 20 of the best long-term stocks. The search begins with proprietary custom screens that focus on the common characteristics of prior Long-Term Leaders. From these screens, IBD market editors handpick the model portfolio. An additional 20 to 30 stocks that pass the screens but don’t make the final cut appear in IBD’s Long-Term Leader Watch List.
Both lists are a great source for ideas to invest in using standard CAN SLIM methods of position trading and even swing trading. But IBD is treating the Long-Term Leaders Portfolio as if it were a real portfolio of stocks, just like IBD’s Leaderboard product. In most cases there will be 20 stocks, each representing a 5% initial position.
As market conditions warrant, we may raise some cash by either removing names or reducing their weighting as part of the portfolio. Also, when stocks start flashing signs that their character may be changing, we may reduce their position size down from the standard 5% to 2.5%. If the stock starts acting healthy again and gives a proper entry, we will bring it back up to 5%. But if it continues to underperform, we will remove it from the portfolio.
At times we may increase the number of stocks past 20. If we were to do that while maintaining the standard 5% weightings, the model portfolio would be considered on margin.
During bear markets we may reduce the number or weighting of the positions to establish a cash component in the model portfolio. For example, if we were to remove four stocks, that would reduce the overall exposure down to 80% in stocks and 20% in cash.
The bottom line is that we are treating this list the same way you would treat your own long-term investments.
How To Make Money With The IBD Long-Term Leaders
It’s important to use the IBD Long-Term Leaders Portfolio properly. Do not buy all the names on the list at once, especially since it’s launching during the coronavirus scare. Many of the names have had huge moves up and are in the early stages of correcting off all-time highs.
When the dust starts to settle from the virus crisis, one by one these Long-Term Leaders will present logical entry points. You then could consider buying them on a case-by-case basis.
Since many of the stocks already have had huge multiyear runs of outperformance, over time some likely will be replaced by new stocks that are just starting their long-term performance.
As the Long-Term Leaders present buy signals, they’ll be highlighted in IBD Long-Term Leaders articles. IBD also will send alerts to IBD Digital subscribers. Depending on how the market plays out, it may take several months until all the stocks present logical entry points.
Please follow Chung on Twitter: @saitochung and @IBD_DChung
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