
The ever-prevailing stock market volatility can scare investors to make impulsive decisions. However, long-term investment in such conditions can be one of the best solutions for such an issue. It is not much affected by market volatility and averages out the investment cost against the returns in the long term.
If managed with caution, equity investments can be one of the best avenues for long term investment objectives. Moreover, it can combat inflation during this investment period. However, selecting suitable stocks for the long term is a crucial task. Investors should consider crucial factors regarding fundamental strength and volatility while making investment decisions.
Here are some crucial factors that can help investors understand how to select stock for long-term investment.
How to choose long-term stocks?
Investing in the stock market can provide exposure to different sectors, companies or objectives. However, volatility and market cycles are an inherent part of such investments. Therefore, investors should focus on diversification for their long-term investment folio.
The foremost aspect of learning how to select stocks for long-term investment is having a basic knowledge of stock market functioning and the sector in which an investor is willing to invest. Further, investors can consider the following factors before making an investment decision.
Fundamental factors
A fundamentally strong and sound entity can combat every market phase or external factor. A company’s fundamental strength is reflected in its statements like profit and loss, balance sheet and cash flow. These 3 documents would indicate the operational, cash-generating and financial position of a company.
- Sales and profit growth
Analyse the past financial statements to understand the company’s growth trajectory in terms of revenue from operations and profit. Moreover, different types of profit can be analysed to determine the expenses affecting the overall profitability. Different profits can be:
- Gross profit: It is most considered for manufacturing companies as it is derived after eliminating the cost of goods from total revenue.
- Operating profit: Also known as earning before interest and tax, this profit eliminates all the operating costs and non-cash expenses from the gross profit.
- Net Profit: It is the clear profit that will also be considered to calculate the earnings per share for equity.
Understanding its growth pattern in light of industry growth and other factors can help investors.
- Comparative margins
The profits calculated in the financial statements can be an absolute indicator. However, to get a transparent picture of the profitability, their margins are calculated. Its formula can be applicable as follows:
Profit margin = (Profit / Revenue from Operations)*100
This profitability can also be compared with companies from a similar sector for better analysis. Moreover, the trajectory of these margins will indicate the potential of a business.
- Earnings per share and dividend distribution
These are stock-specific aspects which present the part earning investors can get as the equity-owners. Earnings per share indicates profit per equity share.
EPS = Net Profit/No. of Equity Shares
From the total profit, a part can be reinvested in the business, and the rest can be distributed among the shareholders. This income is known as a dividend. Investors can calculate dividend yield to understand their dividend income against the investment cost.
Dividend yield = (Dividend per share/Current market price of a share)*100
Dive deeper! Introduction to Fundamental Analysis
Valuation factors
Understanding how to choose long-term stocks is also concerned with their potential valuations in the market. Here are some of the metrics that can help decide the valuation.
The price-to-earnings ratio will indicate the current market valuation of the company against its actual earnings per share. Investors can decide their potential entry-exit prices for a particular stock based on the P/E ratio. The formula for price to equity is as follows:
P/E ratio = Current Market Price/ Earnings per Share
High prices to earnings indicate overvaluation and vice versa. However, it may differ based on the industry.
It is a unique metric calculating valuation against the growth rate. Investors can decipher how their earnings from shares are growing along with market valuation. The PEG ratio formula is as follows:
PEG = (P/E ratio)/Earnings per share
Must read: Mastering Share Valuation: Methods and Key Factors Explained
Technical factors
Some technical indicators like the volatility index (VIX) and moving averages can also help analyse the market conditions and potential price movement. However, technical factors or indicators are not necessary for analysing fundamental positions. They can potentially provide an edge to the regular analysis.
Other tips for long-term investments
Here are some common tips that can help investors understand how to choose long-term stocks efficiently:
- Diversify your portfolio in suitable sectors to balance the risk.
- Volatility is an inherent part of the market. Therefore, long-term investors should keep calm during such times and avoid impulsive decisions.
- Consult financial advisors or market experts for better guidance.
- Stay moderately updated with market happenings and factors of concern.
Bottomline
Long-term equity investments play a crucial role in providing desired financial safety for the uncertain future. Investors can explore different fundamental and valuation factors that can solve their query of how to select stocks for the long term. Following an informed investment analysis can provide reliability to their portfolios.
Explore this easy guide: How to Invest in the Share Market: Comprehensive Guide
FAQs
- How can I balance my portfolio for long-term investments?
Creating a diverse mix of assets is the key to a balanced portfolio. For long-term investment exposure and returns, investors can further diversify in the equity segments as per their preferred sectors. Stock from different sectors can benefit the portfolio in the long term. Moreover, investors can use other assets like debt and mutual funds for balancing their portfolio exposure.
- Which type of stocks are suitable for long-term investment?
The stocks with strong and sound fundamentals and trading at undervalued prices are suitable for the long term. The suitability of specific sectors may differ based on an investor’s portfolio. Investors can analyse the financial statements like cash flow, profit and loss, and balance sheet for selecting the sound stocks for investment.
- Which is better, fundamental and technical analysis?
Both fundamental and technical analysis plays a crucial role in stock selection. However, the investment objective and time horizon should be considered. Technical analysis is suitable for short-term entry-exit. Fundamental analysis tools are crucial for long-term investment plans. Investors can select the suitable analysis method based on their investment horizon.
- Does market volatility affect long-term investments?
No, the short-term market volatility may not have much effect on the long-term investment portfolios. However, the falling market may provide potential entry opportunities for fundamentally strong long-term investments. Investors should avoid making emotional decisions in haste during such volatile situations.
- What does the P/E ratio indicate?
The ratio of current market price to the earnings per share indicates its valuation levels for a stock in the market. A high P/E ratio hints at an overvalued stock, while a low P/E ratio shows an undervalued opportunity. However, it may differ based on the industry.