Three Stocks for the Long Haul

By Rupert Hargreaves - March 9, 2013 | Tickers: CL, V, WFC | 0 Comments

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When looking for stocks to buy and hold for the long-term, two points are very important. Firstly, there is size, since in long-term investing bigger is better. Second is the requirement for the company to be the best in the market and sector, which gives it a competitive edge. If the company is the best in the sector now, it is highly likely that it will continue to be so.

The picks

So, these are three perfect stocks for the long haul, based on size and best of breed:

Visa (NYSE: V) - the bigger of the two main payment transaction networks. Valued at around $106 billion Visa way bigger than its smaller competitor MasterCard, which is valued at around $65 billion. Visa is going around for the long haul, the company is everywhere! I am willing to bet that there is a Visa logo within five feet of anyone reading this right now (or even five clicks)! Visa carries out billions of transactions every day, and I don't believe this will change any time soon.

Wells Fargo (NYSE: WFC) – Wells Fargo is competing to be the biggest bank in the world by market value, although it does lag its competitors in deposits. JP Morgan is its rival, but considering JP Morgan's significant trading risks (the whale), Wells Fargo could be the safer choice. Wells Fargo is nearly the biggest bank in the world, and with the majority of its lending in long-term mortgages, the company is going to be around for a long time.

Colgate-Palmolive (NYSE: CL) – Colgate-Palmolive is not the biggest in the consumer products category, but, as I will explain later on, I believe it is the best and significantly outperforms its larger rival Procter & Gamble. A manufacturer of toothpaste and other personal hygiene products, once again I would be willing to bet that about 90% of people reading this will have used a Colgate-Palmolive product. Colgate's products will always be in demand, unless we all lose our hair, stop practicing oral hygiene, and stop keeping pets (it is very unlikely, if not impossible that all three will happen at once)

A quick chart highlights the difference in size between the companies and their closest competitors.

The past five years have been tough

I don't need to state how tough the last five years have been for most. Indeed, the economic troubles continue to hamper the global economy.

However, over the past five years, each one of these three companies has grown, while Visa has doubled its revenue. 

The table highlights the revenue growth of the three companies over the last five years. Visa has grown the most, as it operates in a relatively defensive industry that will always see plenty of activity. Even though consumer spending may have slowed in Europe and the U.S. over the past five years, Visa is still seeing plenty of activity around the rest of the world as credit becomes more readily available.

Colgate has been the slowest grower of the three, but has grown revenue slightly faster than Global GDP (5-yr global GDP growth = 15%). It can be assumed that due to the nature of Colgate's products, the company will eventually meet saturation point, and will not be able to grow revenue. However, Colgate will be able to generate a very high, sustainable cash flow.

That said, currently Colgate's free cash flow does not reveal the company's true cash flow potential.

Why is that? Well, Colgate converts about 20% ($3 billion) of its revenue into cash, of which it then returns about 80% ($2.5 billion) to shareholders through stock buybacks and dividends. The final $500 million is used for capex. This distribution of cash hurts the final free cash flow, but improves shareholder returns. (Figures as of 2012.)

Visa, in comparison, converts 50% ($5 billion) of its revenue into cash, only returning 20% ($1 billion) of this to shareholders, which gives the company a lot of free cash left over. (Figures as of 2012.)

My data for Wells Fargo is incomplete for 2012, but on a quarterly basis the company had a negative free cash flow for the first three quarters of 2012, which was due to a significant increase in current liabilities and buying of investments.

Return on equity is a key metric. Shareholder equity is effectively assets takeaway liabilities. A return on equity is how much income the company generates based on that equity. The ROE figure above is an average per year for the past five years.

Wells Fargo has produced the smallest return, but when considering the effect of the credit crunch, the return is impressive. In addition, even though the five year average is 5%, during 2012, Wells Fargo had shareholder equity of $150 billion and produced $15 billion net income, which is a 10% return. As the U.S. economy improves I believe this figure will continue to grow. 

Visa's ROE is about 10% on average. Now, while this does not seem large, it must be taken into account that Visa has a huge net asset position because of its cash generative nature. Visa has $40 billion in assets and only $11 billion in liabilities -- which means shareholder equity equates to about $29 billion. As Visa converts 50% of its revenue to cash, the company would be hard pushed to achieve a better ROE as the more it makes in revenue, the greater its shareholder equity will become.

Colgate has produced the best average yearly ROE. It has had an average shareholder equity of $2.5 billion over the past three years, while it has produced an average net income of $2 billion -- a very good return.

Debt

When investing for the long-term, it is key to consider current debt positions. If a company is reliant on borrowing, or is in the middle of a spending binge, then this can have an impact on the its future financial position due to rising interest costs and the ability to re-finance debt.

Colgate's level of net gearing is high when compared to market capitalization. However, when net debt to EBITDA is taken into account (as the company's market cap can fluctuate wildly), Colgate has a ratio of less than one -- signifying that if it wanted to, it could pay off all of its debt in the space of a year. 

As a bank, Wells Fargo's debt is difficult to analyze. However, these statistics shed some light on the balance sheet. Wells has a loan to deposit ratio of 90%, meaning the company is not lending out more than it has in its vaults. In addition, Wells has a tier one capital ratio of 11.3%, above the average 7%-8%. As a bank goes, I believe Wells' balance sheet is well provisioned.

Finally there is Visa. Visa has no debt and a cash balance of $7 billion. Total assets are more than three times greater than liabilities. Even if all of Visa's revenue suddenly disappeared, and the company was left with no income, I believe due to the automated nature of Visa's operations, the company would be able to continue operations, and pay its current dividend for 3-4 years from its current cash balance alone.

Overall

So, in the search for sustainable long-term investments, these three stocks all meet the requirements. They are all the biggest, the best, highly cash generative, and have solid balance sheets. In addition, all three stocks are involved within sectors and industries that are very long-term.

Visa, Wells Fargo, and Colgate are companies that are able to run themselves. They are financially sound and make the perfect investments to buy and forget for the long term investor.

Data Source: Motley Fool CAPS, MarketWatch

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