Every investor should have a top five. These would be the investor’s five favorite companies that they would want to own. These five companies should be businesses that you would like to own for the next ten years. Ten years is important because the longest recovery period in the last one hundred years in the US is from the 1929 great depression which took about seven to ten years to unwind, so statistically using this mindset puts the odds in your favor. This means your top list must be businesses that have durability to with stand the changes that will occur in the future.
Of course it is important that you understand what would be fair valuations of your top five list. Take into account that in strong surging markets PE ratios will tend to inflate, so having a good tab on the company’s industry norms is a good idea. Also, make sure you understand the companies core businesses, and check to make sure they have or generate good cash. Cash is the gasoline of business. Without it a business needs debt, and as we saw in the 2007 recession the credit markets dried up, so the cost of borrowed capital became much more expensive. Also, I like to go back and see how a business survived through a recent recession. It can put some perspective on the company’s ability to withstand a non-business or non-industry related economic challenge.
Lastly, your top five list can be a top ten list, or a top three list. I think five is a good number of companies to choose from. Update your list every six months to make sure that nothing better has come along or that something hasn’t changed with one of the companies on your list. Then lay low in the grass and wait for opportunity. The most successful investors are very patient.