What Qualities Make a Stock a Forever Holding?: No. 3 -- A Fine Set of Financials
A good investment can be a lot like a good relationship: The wise among us pick their partners carefully and they're looking ahead to the long haul. And asMotley Fool fans well know, one key to Foolish investing is the buy and hold philosophy -- no high-frequency day trading going on here!
On this episode ofMotley Fool Answers, Alison Southwick and Robert Brokamp are joined by Jason Moser as he breaks down what he looks for in a "never-sell" stock. Next attributes on the agenda: a balance sheet and cash flow that lets the company operate long term without needing to go hat in hand to the capital markets.
A full transcript follows the video.
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This video was recorded on August 2, 2016.
Alison Southwick: Let's move on to the financials. Let's talk about financials. What are you looking for when it comes to the balance sheet? The income statement? How much do I have to dig into this?
Jason Moser: What you want to make sure you have is a business that is not going to be beholden to the capital markets in order to do its thing for long, sustained periods of time.
Southwick: What do you mean by the capital markets?
Moser: Having to take out debt by issuing bonds. Having to issue more shares to dilute shareholders in the process. It's nice when you see a business that generates a lot of cash via its operations. I think Chipotle(NYSE: CMG)is a very good example of a business like this.
We know that Chipotle owns all of their restaurants. They don't franchise, and they have somewhere around 2,000 today. But the restaurants, themselves, don't cost a whole heck of a lot to open up and get started. It's somewhere in the neighborhood of $800,000 or so. They realize the return on that investment, which is basically just getting back to break even via the sales from the restaurant somewhere in the neighborhood of a year to a year and a half, depending on where they open it.
Now from there, those restaurants just become virtual cash machines, and they're able to take that cash and redeploy it back into the business to open up more stores and grow their presence. All the while, they're able to build up their balance sheet with more and more cash. They don't have to take out debt. So all the while, here, they're able to self-fund growth at a deliberate pace according to their timeline. They never put themselves in a financial pickle, so to speak.
And in times like these -- they're just recovering from this big E. coli crisis -- this has been a big crisis. I think it's been the biggest test of their 22 or 23-year history. They have been very good about executing share buybacks at what they feel are very depressed levels of their shares today, so their share count is not going up. It's actually coming down and they're still recovering from this crisis OK.
So assuming we don't see any more headlines, and they've got their food safety standards in order, I think that 2016 is going to serve as a wonderful year to actually build or add to your position in Chipotle, because down the road, again, we talk about repeat purchases and businesses that have demonstrated pricing power throughout the years. Chipotle is another one that has done that, and it's done it in a fiscally fit way.
Southwick: I'm a pretty novice investor, so it's seems kind of funny to me that we should invest in companies that are profitable.
Moser: Sure!
Southwick: It's like that makes sense. I guess there are people out there who invest in companies that are not profitable.
Robert Brokamp: Well, yeah.
Moser: And in today's tech world, that is very common. You see a lot of businesses that get started. They go public early in their lives and they have to invest so much up front to build out the tech in that business, that they aren't profitable for some period of time.
That's where you really want to take a look beyond the financials and understand exactly what the power of this business is. Is there a network effect or a utility where we can see this business being relevant 10 years from now? And if that's the case, then you can look past the financials at potential future earnings power and determine when and if they will become profitable.
Alison Southwickand Robert Brokamp, CFPhas no position in any stocks mentioned. Jason Moser owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.