People invest for one primary reason, to earn money off their existing capital. Whether the earnings are for retirement, purchase a home, or any number of financial ambitions we all want to maximize our return. The timetable for using the principle and the earnings dictates the appropriate investment choice. For those with a longer interval before needing to cash out the investment, stocks may be a wonderful investment. But how should one select a stock for a long term investment?
Long term stock investments can earn in two ways, through appreciation of the stock between the purchase price and the sell price and/or through dividend distributions. There are several important variables to consider to find the right mix of earnings, but the most important are Dividend Yield, Earnings per Share (EPS), and EBITDA.
Dividend yield is obvious, it indicates at what rate the organization has paid dividends in the past. Checking for past dividends is important as it is not a given. There are many corporations who do not pay dividends as a policy and instead revert those earnings back into the organization. The lack of dividends does not make such an organization a bad investment however; well run companies can often leverage that cash into higher earnings in the next period and so on which adds to appreciation of the stock price in the long run.
EBITDA is the common acronym for Earnings before interest, taxes, depreciation, and amortization. This figure is important as it gives a more comparable figure when looking at the financial health of multiple organizations. If you rely solely on the bottom line, variables such as depreciation methods and tax strategies can distort your evaluation. A strong EBITDA over the course of multiple years is a good indication that the organization is operationally sound.
How to Select a Stock for Long Term Investment
Here is a practical look, let’s say you enjoy books so you look at the Nation’s largest book retailers as potential investments. Below I have the key financial statistics for Books-a-Million and Barnes & Noble (via Yahoo Finance). Ideally you would want to have the last 3 years for comparison, however this allows a practical example nonetheless. Neither offers a dividend; Barnes and Noble obviously has significantly higher market share based on EBITDA but both have a negative EPS. My decision here would be to look at a different industry, obviously brick and mortar book retailers aren’t a great investment right now. Despite being poor investments, this gives an idea of how these key statistics can allow for informed decisions.
In order to select a stock for long term investment, you must look at an organization’s dividend yield, it’s EBITDA, and it’s EPS. By analyzing these key metrics, you as an investor can get a feel for how much regular income can be expected via dividends as well as the ability to rate the organization’s soundness in terms of both operational and financial management. There are certainly more in depth analyses which can, and should, be performed, however these tools allow you as an investor to understand the organization you are considering as a long term stock investment opportunity.