7 Traits of Highly Profitable and Sustainable Companies

Value investing guru Warren Buffett have followed these rules to identify good stocks. Don't invest in stock unless you have read this. Stable and increasing sales, earnings and cash flow
Good companies worth investing in should have stable and increasing sales, earnings and cash flow for a 5 years track record in a row. You can find these information in the income statement to find out more information on this. You can find financial statements for companies at sites like http://anualreportservice.com , http://finance.google.com and http://www.morningstar.com

Competitive advantage

My favorite book on competitive advantage is "Competive Advantage: Creating and Sustaining Superior Performance" by Michael E. Porter. Basically, there are two basic types of competitive advantage. They are cost advantage and differentiation advantage.

A good company must have sustainable competitive advantage in order to prevent competitors from coming in and steal the market share. Other types of competitive advantage could come in the form of brand loyalty, patents, technology, economy of scale (which results companies to purchase cheaper supplies or lowers the cost of production than other competitors due to the size of the organization), high switching costs for customers and market leadership

Companies that are not worth investing in are companies that sell commodity type of products or services and compete on cost efficiency. A good company is one where the company increases the prices and the demand is not that much affected. For companies like MacDonalds, Gillette and Harvley Davidson, they have strong brand loyalty. It would be impossible for new companies to come in and compete on pricing along.

However, stock prices of such companies might seem significantly overpriced at this point in time. The secret is to purchase when the market has underpriced the stock.

Future Growth

Look under shareholder's reports for companies for news on future growth like development of new product lines, expansions for production, new patents and new stores,

Conservative Debt

A healthy financial statement should not have long term debt 3-4 times current net earnings (after tax) It means that a company is able to clear its debt within 3 - 4 years. Return on Equity

Return on equity is another important figure to look at in a company's statement. A high return on equity shows that the company has a high sustainable competitive advantage. It is recommended that you choose a company with at least 12% return on equity

Return on Equity (ROE) = (Net Income / Total Shareholder Equity) x 100%

Low Capital Expenditure (CAPEX) to maintain current operations

Our investment guru Warren Buffett avoids companies that have high CAPEX as the companies have to spend a significant amount of their earnings to replace and maintain expensive machinery, instead of spending the earnings to expand its operations. If Warren Buffett doesn't choose that, why should you?

Whether management is selling or buying their own stock

If the top management has been selling a significant amount of their shares, it shows that they do not have confidence in their own shares at the current prices. Perhaps, the prices have been overvalued and they are selling the shares for profit.


by by Keith Lee