Here's How an Investor Could Find Stocks to Buy for Early Retirement

Buying stocks and letting the dividends or capital gains accumulate can be a lucrative way to prepare to retire early. But that plan requires an investor to decide which stocks to buy.

Here is an approach an investor might consider.

Starting with the end in mind

To increase the value of the portfolio in the decades before retirement, so that it can produce an income through dividends, an investor might choose growth stocks, income stocks, or a combination of both.

The long term involved here could allow for a share of growth to show its real potential, as a young business blossoms into something much bigger.

But that deadline could also allow the power of composition to be demonstrated. For example, compounding a portfolio of income stocks at an annual rate of 7% would mean that it should grow by 661% in total over a period of 30 years.

In search of long-term value compounds

In that context, it might make sense for an investor to buy growth or income stocks down the road. Any of which could compound in value over time.

But I think a key point to ask is: What does the future look like?

In other words, investing for decades ahead is not necessarily the same as someone with a short-term mindset looking for stocks to buy.

Therefore, it may be helpful to think about which industries might be thriving decades into the future.

That could be earlier: for example, I hope insurance continues to be a big business. But it could also be a new one: Three decades ago, search engines and social media were in their infancy, but both are now big revenue generators.

Still, in any large or potentially large industry, how could an investor decide from the different stocks available which ones to buy?

Why a proven business model can help investment decisions

One approach is to look for businesses that have a proven business model.

That might mean ruling out some real disruptors who go on to be massive successes. But, hopefully, it could also mean avoiding many early-stage companies whose number one skill is burning cash.

A proven business model doesn't just suggest that a company has what it takes to make money. It can also suggest that a company is being run by real business managers, not people who confuse having a great idea with having a great business.

An example in practice

To illustrate, let's look at a stock I think investors should consider: Giant Beverages Diageo (LSE: DGE).

There are risks to long-term market demand, such as lower enthusiasm for alcoholic beverages among young people compared to older generations.

But I still think the beverage market is likely to remain massive.

Diageo has some competitive advantages that allow it to compete and make profits. I think they could hold out for a long time. Its portfolio of premium brands is a great asset, but so is its network of unique production sites (such as famous Scottish distilleries) and extensive global distribution network.

It has increased its dividend per share annually for decades.

After a 24% share price in five years, I think the price-to-earnings ratio of 18 now looks reasonable for such a great, proven business.