As an investor, I like to invest in companies with proven business models. So it may seem that the FTSE 100 index makes a natural hunting ground, thanks to its plethora of sizeable, well-established enterprises.
Even in the FTSE 100, though, there are some shares that do very well and others that perform terribly.
Here is a handful of things I pay attention to when scouring the FTSE 100 for shares to buy.
1. Focus on the future
Companies are elevated to the leading index due to the size of their market capitalisation. In some way, that can make the index rather backward-facing. Mature industries in decline can still be represented, while fast-growing sectors of the economy might not be.
As an example, consider tobacco.
Might British American Tobacco and rival Imperial Brands be remnants of a bygone era? Both saw revenue declines last year despite having strong pricing power.
2. Sustainability of the business model
National Grid is a popular pick with income investors, thanks to its beefy dividend and policy of aiming to grow the dividend in line with inflation.
Yet I do not own the share. Why? I think the business model is less lucrative than it may seem. Sustaining it could require more money.
Yes, power distribution networks are likely here for the long term. But maintaining or changing them is very capital intensive. That helps explain why National Grid diluted shareholders this year to raise cash.
3. Buy the business, not the rumour
As nationally recognised companies, FTSE 100 firms often pop up in takeover rumours. Buying a business that then gets taken over can mean a quick profit.
But I see that as speculation, not investing. I invest in a share only because I like its business prospects and current valuation.
4. Always pay attention to valuation
When buying any share, I think valuation matters – and that applies to the FSTE 100 too.
Consider Spirax (LSE: SPX), the engineering company that has an unbroken record of annual dividend per share increases stretching back over half a century.
The business performance has not been stellar lately. While revenues hit an all-time high last year, basic earnings per share fell 18%. With ongoing demand weakness in China, I see further risks for the steam and industrial fluid system specialist.
But I still see it as a great company and would happily own the shares. It has a sizable addressable market, proprietary technology, a large installed customer base, and strong reputation.
But is this FTSE 100 share, down 36% so far this year, worth over 20 times earnings?
I do not think so, which is why I am not buying.
5. Consider what sets the firm apart
As with any share, I look for a competitive advantage that I think helps set a firm apart from rivals.
FTSE 100 firms like Haleon and Unilever have portfolios of unique brands that give them pricing power.
Billionaire investor Warren Buffett, who tried to buy all of Unilever in 2017, always looks for a business to have a “moat” that helps it fend off rivals.
This post was originally published on Motley Fool
