Growing up, you probably had a favorite baseball player. Being a Philadelphia native, mine was Mike Schmidt. Considered probably the best third baseman of all time, Schmidty led the league in home runs for eight seasons, RBIs for another four, and sits at number 14 on the all-time home run list.
He was a true slugger, and I loved every bit of him.
Was Schmidt really that good?
Like every baseball fan, I spouted off stats like they meant something, but as Michael Lewis points out in Moneyball, stats are deceiving in several ways. They magnify essentially small differences, they conflate circumstances with skill, and they're often looking at the wrong thing.
For example, we place absurd emphasis on home runs and RBIs. While RBIs are considered an individual achievement, to knock runners in, runners have to be in scoring positions. The best swing in the world won't earn RBI points if the bases are empty.
And it turns out that, in the end, home runs and RBIs are poor predictors of overall success. The metrics that matter, however -- on-base percentage and slugging percentage, especially in combination -- aren't very well known.
Johnny Bench? Reggie Jackson? They come to mind as some of the greatest players of all time, but what about Stan Musial? Or Mel Ott? Both of the latter players are significantly lesser known, yet the stats that matter are just as good or better. They're on the all-time list for walks, and consequently, they have higher OBPs than both Johnny Bench and Reggie Jackson. Oh -- and they have World Series rings as well.
I thought you were supposed to talk about stocks
The same problems with numbers happen in investing as they do in sports. The exciting, easy-to-find numbers often obscure the deeper stats that make the real difference between success and failure.
For instance, I often look for companies with low debt-to-equity ratios, substantial free cash flow, and forward growth rates above 15%. Both Crocs (Nasdaq: CROX ) and Marvell Technology Group (NYSE: MRVL ) fit the above criteria. However, when I dig deeper, I find that both have negative returns-on-equity and have had problems sustaining revenue and earnings growth. Low debt and positive free cash flow (they usually come together) are excellent traits -- but they don't outweigh other problems.
If I'm looking for stable, dividend-producing stocks, I usually seek out companies with low multiples, high yields, and positive returns-on-equity. Annaly Capital Management (NYSE: NLY ) , Cherokee (Nasdaq: CHKE ) , and Reynolds American (NYSE: RAI ) all look great on the surface -- until I realize they have payout ratios of 163%, 149%, and 99%, respectively. High payout ratios can be a great indicator of companies that are vulnerable to dividend cuts or that are living beyond their means.
The bottom line: On the surface, all of these companies look like home runs. But when you look at the numbers that really matter, they're companies that you should be wary of.
The complete package
Hank Aaron has it all -- he's on the all-time home run list, he's on the all-time walk list, he has a World Series ring, and most importantly, he has an on-base percentage that rivals most. He's the complete package -- and you want the same from your stocks.
The experts at Motley Fool Stock Advisor use the same philosophy when recommending great stocks. They look for attractive valuations, clean balance sheets, and stable companies, but they also look at the whole picture -- just because a company has great cash flows doesn't necessitate a "buy." Just because a company pays extraordinary dividends doesn't mean it will continue to do so in the future. They keep digging; statistic after statistic, until they find stocks that form a complete package.
For instance, Cintas (NYSE: CTAS ) has been increasing their dividends for 26 consecutive years, has a low payout ratio, a low debt-to-equity ratio, and has consistently grown revenues over the last five years. Stock Advisor recommended it, and it's beating the S&P by over 7 percentage points since that recommendation.
Tom and David Gardner, co-founders of the Motley Fool, recently advised members to buy Cubic (NYSE: CUB ) , a company that specializes in the design and development of defense electronics. Cubic has almost zero debt, significant free cash flows, and a 10-year annual growth rate of 18.8%. Furthermore, the 93-year-old owner and founder (yes -- 93!) has consistently delivered to shareholders and owns lots of stock himself, something that is always a great sign when searching for dedicated management.
If you want to outperform the market -- and Stock Advisor is outperforming the S&P 500 by 52 percentage points -- then you've got to find stocks that meet all of the important criteria, not just the most popular ones. If you'd like to see what else fits that bill, you can sign up for a free 30-day trial --- there's no obligation to subscribe. Just click here to get started.
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Fool contributor Jordan DiPietro doesn't own any of the shares mentioned above. Cintas and Cubic are Motley Fool Stock Advisor recommendations. Cintas is an Inside Value pick. The fool's disclosure policy is an avid Philadelphia Phillies fan.