One Secret to Investment Success as Market Rally Enters Fourth Year

Tuesday, 13 Mar 2012 09:26 AM

By Andrew Packer

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Last Friday marked the third anniversary of the stock market rally. Since that time, indices have roughly doubled from their financial-crisis lows.

But investing is about looking forward, not backward. And as we mark this occasion, the horizon ahead is cloudy.

Why? For starters, the easy gains in the market are gone. Three years ago, a seasoned stock picker or someone throwing darts at a list of stocks could have both done well. There was no skill required. Looking forward, it’s increasingly becoming a market for individual stock selection.

The root causes of the financial crisis remain. Banks still need to clear bad loans off their books. Rather than force banks to deal with these problems outright, regulators have simply allowed banks free reign to pretend. Government spending policies have helped to create the illusion of prosperity, but structural problems remain.

Yet, there’s some good news out there.

Stock market valuations are, overall, great if not fantastic. On an inflation-adjusted basis, stocks are at multi-decade lows, having peaked in absolute terms at the peak of the tech bubble. While many companies are sitting cozy near 52-week highs, on traditional valuation metrics such as forward earnings and return on equity, there hasn’t been a better time to buy stocks in more than a decade.

As we enter into the fourth year of the market rallying, there’s one simple way to screen for quality. I hinted at it in my blog last week, when I talked about the popularity of Apple (AAPL).

Simply put, you want to invest in companies where customers aren’t just looking for a one-time purchase or to buy something as cheaply as possible. You want customers who are making repeat purchases because it’s part of their brand, their lifestyle.

When you have a product that customers love so much they tattoo it on their body — like the Harley Davidson (HOG) logo or a favorite Disney (DIS) character — you know you’ve got a company that can maintain strong earnings and face any competition. Long-term, that’ll be great for the stock.

McDonald’s (MCD) estimates that 80 percent of their business comes from “core customers.” That’s defined as people who eat there at least five times per week. For those core customers, eating at the golden arches is part of their lifestyle.

Sure, I could talk about a company’s financial advantages and how it’s powered by a strong brand. But it really boils down to how the customer responds. This simple tool can allow any investor to filter through the investment universe to find companies worth owning for the long term.

This is exactly the kind of simple, effective solution that solves the problem of a stock market rally that’s long in the tooth. By rotating to quality companies that enjoy a fanatic customer base, investors will likely be amply rewarded over the long term.

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