Three Quick Rules For Long-Term Investors

The best investors – think: Warren Buffett or Peter Lynch – have long-term, buy-and-hold mindsets. That means buying stocks and owning them for years, or even decades. But that can be hard to do for us non-legends. Even if we know that stocks go up most of the time, on any particular day, week, or month, or year it’s easy to lose sight of. And, let’s face it, when you haven’t reaped the gigantic rewards those investing icons have, it can be tempting to take a quick profit or to cut your losses.

So here are three investing rules that you can use to adopt a long-term, buy-and-hold frame of mind – and a checklist to help you maintain it.

1. Avoid the industries that are at risk of disruption.

OK, this one does sound obvious, but if you want to own a company’s stock for the long term, you’ll need to be confident that the demand for what it does will still be going strong in the future. This isn’t about trying to find disruptors – those firms with the power to upend an industry – it's about making sure you’re not investing in something that might get disrupted.

Let’s take travel as an example. I’d say it’s pretty likely that in ten years, people will still want to take vacations. That means they’ll probably want to stay in hotels. Now, I’m not saying that every hotel stock is automatically a good investment. But I am saying that the hotel industry will probably still be going strong in ten years, and that’s something to build off.

2. See what the management incentives tell you.

When firms run into a spot of bother, which they all do, it matters who’s at the helm. Does the management team have the experience and skill to steer the ship through a storm and into calmer waters? Will it be early to spot danger and take swift, evasive action? These are important questions, but they can be tough ones to answer without understanding the individuals in the corner offices or the cultures they’ve built. Perhaps the most important management-related question you can ask, though, is whether a firm’s incentive structure aligns management with shareholders. In other words, is the top brass rewarded for making decisions for the long-term benefit of the company, and therefore its shareholders?

Luckily, there are plenty of ways to get the answers. Companies file proxy statements with the SEC – often called 14A filings. They’re an absolute treasure trove of information on executive compensation, and there’s usually some pretty eye-opening stuff in them too. Would you believe that Apple CEO Tim Cook got $350,000 in 2022 for just sitting on Nike’s board? Just for sitting there. Anyway: you’re looking for a compensation package that rewards senior execs for making good long-term decisions: for example, shares that are granted at today’s price but that don’t vest (i.e. become available to sell) for many years.

Take a look at this snippet from a Nike statement on executive compensation. Of the $20 million paid to the company’s CEO, only $1.5 million was salary. The vast majority of his pay was stock-based – and most of that was structured to be long-term oriented. Now, that doesn’t guarantee that Nike’s boss will make all the right long-term stock-boosting calls, but with tens of millions of dollars riding on it, you can assume he’ll give it his best shot.

Nike’s proxy statement shows that only $1.5 million of the CEO’s $20 million total compensation was base salary. The rest was stock-based pay, weighted toward long-term incentives. Source: Nike.

3. And sidestep the bombs.

In theory, you could make money buying down-and-out stocks that eventually become stunning turnarounds, but that’s a tough skill to master. And, in the meantime, you could easily end up investing in a few bombs – that is, a company in an industry that’s being disrupted, one that’s led by a poor management team, or one that’s carrying too much debt. Avoiding those is hugely important. You’d be surprised how well you can do over time by just sidestepping the torpedoes that are out there.

To help you stay on track with all three rules and avoid the bombs, I’ve come up with this handy, four-point checklist. It might not make you a Buffett or a Lynch, but it could help keep your long-term goals in focus.

Your four-point checklist:

Ideally, you’ll want to be able to check “yes” after each of these.

• Are you confident this industry will be around and thriving in ten years?

• Is there a long-term incentive plan built into the CEO and CFO’s compensation package?

• Is the firm built on solid foundations, with manageable levels of debt and consistent sales and profit performance? (A quick debt test is to calculate the ratio net debt (debt minus cash) / earnings before interest tax depreciation and amortization, or EBITDA. If net debt is more than three times EBITDA, spend some time thinking about why and whether the firm’s got a plan to repay the debt.)

• If the stock has been underperforming for a long time, do you have reason to think it’s just a temporary thing? Or is the industry being disrupted, creating serious concerns about financial stability?