When you invest in companies for the long haul, buying quality is critical. Sure, you might make some fast money buying a dicey company on a hot streak, but it’s just as easy to lose most if not all of your original investment if the company runs into trouble. Quality growth companies make for a more relaxed approach to investing—not only can you assume less risk to earn your return, but you spend less time studying stocks because their past performance can be a good indication of what you can expect in the future.
Just as with consumer products, the quality of a company isn’t just about numbers. Quality can be the number of skilled executives on the management team, the steady introduction of successful new products, revamping older products for new uses, dealing with problems that arise, and making the most of opportunities.
However, fundamental analysis does use financial measures and ratios to quantify quality. Strong, consistent growth is one good sign of quality. Many companies have turned in one spectacular year of growth, but the pickings are much slimmer when you demand a steady track record of strong growth for five or more years. You can also see quality in the financial strength of a company, the amount of money invested in research and development, steadily increasing profit margins, and above-average return on equity. Depending on the industry, different ratios might hold the key to quality. Regardless of the ratios you evaluate, you want to see trends moving in the right direction and numbers that compare favorably to those of the competition or the industry average.