3 Stocks That Just Make Sense

"I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out."
-- Warren Buffett

History seems to show that good investing doesn't necessarily mean picking out complex situations and basing your investment thesis on Nobel-level math. In fact, as the recent financial crisis has shown us -- not to mention Long Term Capital Management and many other examples -- too much complexity can often end in calamity.

In an effort to track down some of the companies that may fall into that "fish in a barrel" category, I looked for companies that have shown signs of brilliance. Specifically, I focused on companies with a conservative balance sheet, annualized operating profit growth of 5% or better over the past five years, a return on equity above 12%. I've also included the ratings that the Motley Fool CAPS community has given each of these stocks.

Company

CAPS rating (out of 5)

Debt-to-Equity Ratio

5-Year Annualized Operating Profit Growth

Return on Equity

Micron Technology (Nasdaq: MU  )

***

31%

35%

24%

Medco Health Solutions (NYSE: MHS  )

****

82%

20%

26%

Exelon (NYSE: EXC  )

*****

94%

6%

20%

Sources: CAPS and Capital IQ, a Standard & Poor's company.

While the three companies above aren't meant to be formal recommendations, they are a good starting point to start some further research. And on that note, let's take a closer look why these potential investments might make a whole lot of sense.

Micron Technology
The numbers sure look nice on Micron right now, but as its three-star CAPS rating suggests, those numbers may be a bit of an illusion.

For example, the compounded annual growth on Micron's operating profit over the past five years is the 35% cited above. However, to only look at that would ignore the fact that the company had a few unprofitable years in between. In fact, over the past decade, Micron's business has lost a good deal more money than it's made.

While the cash flow side of the picture may seem to paint a more positive picture since the company has steadily maintained positive operating cash flow, all of that cash flow -- and then some -- has been pumped back into capital expenditures. That may have kept the business competitive, but it doesn't help investors who like to see cash accruing in their side of the ledger.

Zooming out to a larger view of the business, the memory industry in which Micron competes is absolutely brutal. Micron has to scrap with tough competitors like Samsung and SanDisk (Nasdaq: SNDK  ) to sell a product that is almost continually falling in price. The landscape is littered with bankruptcies and failed companies -- including Spansion, which recently re-emerged from bankruptcy protection.

The numbers may line up right now, but it'd be tough for me to say that Micron is a stock that's ripe for the picking.

MedcoHealth
From a numbers perspective, pharmacy benefits manager Medco Health is in a much different position than Micron. Since being spun off from Merck (NYSE: MRK  ) back in 2003, Medco has been a solid profit producer, not to mention a free-cash-flow machine. So when it comes to growth and profit, Medco is no Johnny-come-lately.

But just as Micron finds itself trying to run the treadmill of falling memory prices, Medco has to deal with the relentless focus on bringing health-care costs down. Being competitive with hard-nosed foes like Express Scripts (Nasdaq: ESRX  ) and CVS Caremark (NYSE: CVS  ) has meant running on very thin margins and trying to goose profits through volume and efficiency.

Volume and efficiency can be great ways to carve out a competitive advantage, but investors have been wary of the company's recent results. Medco's gross margin for the June-ended quarter was 6.5%, down from 6.8% in the prior year, while the closely watched metric of EBITDA per adjusted prescription fell slightly from $3.07 to $3.06 year over year.

The stock is down nearly 8% since those results were released, giving the stock a price-to-earnings ratio of 14.6, based on expected 2010 results. With management expecting the full year to show 20% earnings growth and analysts predicting 17% annual growth over the next five years, it seems investors may have gotten a bit too pessimistic.

Exelon
There are two primary reasons I've got my eye on Exelon's stock: the dividend and its nuclear generation assets.

In the recent rough-and-tumble market, it can be tough to hold your nerve and conviction. Not only do I think dividend-paying stocks are often better-run, more stable, and more shareholder-friendly, but the cash they deposit in your account can be a good antidote to the market jitters. If you ask me, the 5.1% payout that investors can get from Exelon is pretty darn soothing.

On the topic of stability, though, it's important to note that Exelon isn't just a regulated utility. The company does own ComEd and PECO, which are regulated utilities in Illinois and Pennsylvania, respectively, but a big chunk of the company's revenue and the lion's share of its profits come from its generation activities. Generating power and selling it on the wholesale market can drive big profits, but it's also not nearly as stable as the steady-as-she-goes regulated utility business.

Of course, it's within the generation business that Exelon has its biggest competitive advantage -- its nuclear plants. Nuclear generation is far cheaper than fossil fuel generation, and this gives Exelon an edge when it comes to competition and profitability.

CAPS All-Star kirkydu recently gave Exelon's stock a thumbs-up, highlighting its position in nuclear generation:

Here a nuke, there a nuke, everywhere a nuke nuke. Exelon is the leader in nuclear energy in America. Its margins are fantastic and coming regulation is likely to favor nuclear over coal. Great holding for any moderate risk equity income portfolio.

It's pretty unlikely that Exelon will deliver multibagger returns during the next few years. However, as a relatively stable dividend payer, Exelon could provide a nice dose of portfolio sanity.

Getting down to business
Now the CAPS community wants you. That's right -- do you think these stocks make sense? Or will they disappoint investors? Head over to CAPS and join the 165,000-plus members already sharing their thoughts on thousands of stocks.

Wish you could find 50 hot stock recommendations? Rejoice, Fool, for your wish has been granted!

Exelon is a Motley Fool Inside Value selection. Medco Health Solutions is a Motley Fool Stock Advisor pick. Motley Fool Options has recommended writing puts on Exelon. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out the stocks that he is keeping an eye on by visiting his CAPS page or you can connect with him on Twitter as @KoppTheFool. The Fool's disclosure policy is chillaxin' because it's too busy to chill and relax separately.


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