These Are the Market's Strongest Buys

The hottest investments in 2009 were, in no particular order:

1. Emerging-market stocks, especially Chinese stocks

2. Bonds

3. Risky, debt-laden U.S. stocks

Following the bludgeoning we took last winter, it's no surprise that investors have either sought lower volatility in the fixed-income market or have tried to regain some ground in more volatile equities.

Those sectors may have been the market's strongest buys last January, when the market was extremely risk averse, but not this January. No, the market's strongest buys today are in the very areas that investors at large have been ignoring -- namely high-quality, U.S.-based blue chips.

Boo this man!
In his most recent quarterly letter to investors, GMO Capital's Jeremy Grantham argued that "Quality stocks (high, stable return and low debt) simply look cheap and have gotten painfully cheaper as the Fed beats investors into buying junk and other risky assets."

It's these companies, after all, that not only have the balance sheets to withstand another shock to the economy in the coming years, but also generate a substantial amount of their earnings abroad -- a bonus for those who believe in the emerging-market growth story and the need for diversification away from the U.S. dollar.

Incredibly, investors have largely shunned a number of high-quality U.S. blue chips in favor of the aforementioned three alternatives.

Consider:

  • Emerging-market stock funds received record inflows of $80 billion in 2009 (topping the 2007 record by $25 billion)
  • Last year, taxable and municipal bond funds took in more than $300 billion versus essentially no change in equity funds.

And that means savvy investors can find some excellent opportunities.

Best buys now
With many investors' attention turned elsewhere, here are five U.S. blue chips that deserve some extra research right now.

To find promising, long-term candidates, my search targeted companies with:

  • Return on equity greater than 15%.
  • Interest coverage (EBIT / interest expense) over 10.
  • Price-to-free cash flow below 20.
  • More than 20% of sales abroad.

Company

Return on Equity

Interest Coverage

Price-to-Free Cash Flow

% of Sales Abroad

Abbott Laboratories (NYSE: ABT  )

27.5%

12.9

14.5

51%

3M (NYSE: MMM  )

22.8%

21.3

15.1

64%

McDonald's (NYSE: MCD  )

32.9%

13.4

17.7

66%

Nike (NYSE: NKE  )

17%

282.0

15.3

66%

Medtronic (NYSE: MDT  )

16.9%

21.0

16.1

38%

Data from Capital IQ, as of Jan. 12.

Now compare these high-quality companies with the financial health of two stocks that have led the junk rally since early March: Dollar Thrifty Automotive (NYSE: DTG  ) and Avis Budget (NYSE: CAR  ) , both of which are up more than 3,000% since the market low last year.

Company

Return on Equity

Interest Coverage

Dollar Thrifty

Negative

0.7

Avis Budget

Negative

0.7

Surely, congratulations are in order for investors who bought into these stocks early March when the market was avoiding risky assets -- both have since become huge multibaggers.

But these "frog-to-prince" stories have not only played out by now, but another downturn in the economy could further rattle these highly leveraged companies.

Coming full circle
At the end of the day, investing is not just about buying low and selling high. It's about being comfortable and understanding what you own. If you don't, you're more likely to panic and make poor trading decisions. In today's market you can have the best of both worlds through buying quality U.S. large caps at good prices.

Simply put, they're the market's strongest buys right now.

I've already given you five ideas to get started, but if you want to find similar ideas for yourself, start by looking for companies with the following qualities.

1. Built to last 100 years or more.

2. Dominating growing industries.

3. Led by committed and proven management teams.

4. Governed by the highest corporate values.

5. Consistently increasing shareholder value.

Our Motley Fool Stock Advisor service believes that Western Union fits the bill perfectly, and it has a place on the team's list of recommended "Best Buy" stocks. If you'd like to learn about the other stocks we're recommending at Stock Advisor, a free 30-day trial to the service is yours. Just click here to get started.

Already a member of Stock Advisor? Log in at the top of this page.

This article was originally published Nov. 6, 2009. It has been updated.

Fool analyst Todd Wenning hopes you had a great holiday. He does not own shares of any company mentioned. Western Union and 3M are Motley Fool Inside Value recommendations. Western Union is a Stock Advisor recommendation. Motley Fool Options has recommended writing puts on Western Union. The Motley Fool owns shares of and has written puts on Medtronic. The Fool has a disclosure policy.


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