Now Is the Time to Upgrade Your Stocks

This time, like all times, is a very good one, if we but know what to do with it.
 -- Ralph Waldo Emerson

Since March 2009's market bottom, we've seen what many derisively call a "junk rally" -- stocks with obvious problems (e.g., debt-laden balance sheets, huge losses, etc.) have risen faster than solid "blue-chip" stocks.

Just look at your favorite multi-bagger -- Ford (NYSE: F  ) , Fannie Mae, Citigroup (NYSE: C  ) , or Las Vegas Sands (NYSE: LVS  ) -- for evidence.

But here's a secret about the so-called junk rally. I don't care whether you label a stock "junk" or you label it a "blue chip." And I don't care about the amazing run-ups that have made your neighbor a killing.

I only care about the answer to one question.

That one question
When a stock doubles or triples or whatevers in price, it's hard to think rationally about it. Bulls think, "How can a stock that created such fortunes be a bad investment?" Bears think, "How can a stock that rose so much be considered cheap?"

This relative valuation problem is the same trick stores play on us. At 50% off, we instinctively believe we're getting a bargain regardless of the absolute price. But, in reality, it's the absolute price that matters -- either a shirt's worth $50 or it's not. It's the same thing with a stock price.

Whether a stock is downtrodden like so many were in March, or it's coming off a huge hot streak like many are now, what we need to focus on as investors is one question:

Is the stock worth owning at today's prices?

How can you tell?
The first thing to realize is that no stock is a sure thing. But some stocks are less likely to leave you heartbroken than others. The higher a company scores on these four attributes, the more you should be willing to pay for its stock:

  1. Strong balance sheet
  2. History of solid profitability
  3. Sustainable competitive advantage
  4. Strong growth prospects

But even if it scores poorly, it may be a good buy if the price is low enough. In fact, if the price is right, a "junk" stock can be more attractive than a "blue-chip" stock on a risk-adjusted basis.

The reason stocks like Ford, Fannie Mae, Citigroup, and Las Vegas Sands rose so much during the rally is because the market had beaten them down to such a low level back in March 2009. The market was driven by fear for the worst, so companies with serious bankruptcy risk were priced as such ... and then some.

You may argue that all stocks were down significantly at the bottom. This is true. Still, higher quality stocks like Johnson & Johnson (NYSE: JNJ  ) , ExxonMobil (NYSE: XOM  ) , Procter & Gamble (NYSE: PG  ) , and UPS (NYSE: UPS  ) , while trading lower, weren't beaten to the floor like the Las Vegas Sands'es of the world.  

A word of caution
But let's not pick nits. Just about any investment made last March has done very well. If you had the fortitude to take advantage, I offer you congratulations -- but I also offer you a warning.

With the stock market no longer priced for financial Armageddon, now is the time to look at the risk-reward profiles of all your holdings. The market has been fairly stable recently, but don't be lulled into a false sense of security.

As the ancient Roman poet Horace put it, "A heart well prepared for adversity in bad times hopes, and in good times fears for a change in fortune."

In other words, now is the time to upgrade your stocks.

Let me upgrade you
Whether your portfolio is full of "blue-chip" stocks or "junk" stocks, you must be vigilant to ensure the current price is fair. The worse the balance sheet, profitability, competitive advantage, and growth prospects of a company, the less a stock should be worth to you. This is the case if you're newly buying a stock or just holding it in your portfolio.

Given all this, I'd be remiss if I didn't give you a couple upgrade ideas for any overvalued stocks in your portfolio.

So I turned to the Motley Fool's founding brothers, David and Tom Gardner, for the stocks they like at today's prices. Both of the stocks below made the "Best Buys Now" list in their monthly investment service, Motley Fool Stock Advisor.

 

Company

Current Stock Price

David's pick

NVIDIA

$15.90

Tom's pick

Cubic

$38.03

If you find a weak link or two in your portfolio, NVIDIA and Cubic are good research candidates to start your upgrade process. If you'd like to see all of David and Tom's "Best Buys Now" (10 total), I invite you to try their Stock Advisor service free for 30 days. Click here to get started. There's no obligation to subscribe.

Anand Chokkavelu owns shares of Citigroup. He may have used Emerson's quote, but he always believes in a Thoreau analysis. NVIDIA, Ford, and Cubic are Motley Fool Stock Advisor choices. Johnson & Johnson, Procter & Gamble, and United Parcel Service are Income Investor picks. The Fool owns shares of Hasbro and Procter & Gamble. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (30)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 05, 2010, at 10:48 PM, baldheadeddork wrote:

    Okay, maybe this is like an undergrad asking Einstein if he's sure about that formula, but I think David's wrong on nVidia. Very wrong.

    No matter how good their books look, this is a company with substantial product problems on the near horizon. Their new Fermi line of graphics processors is running into massive problems as they try to start production, and even if they fix the yields this is going to be a chip that uses much more power and creates more heat than the new AMD 5xxx series. Mobile devices are the growth market for graphics chip makers and heat/power consumption are the top issues. (See here for recent tech article on nVidia's troubles with Fermi: http://www.semiaccurate.com/2010/01/17/nvidia-gf100-takes-28...

    Their chipset business is going away, too. Making motherboard chipsets for AMD processors has been a major source of revenues for nVidia in the last decade, but AMD and Intel are both moving chipset functions to the CPU in all future designs.

    If the stock is priced correctly today is important, but if where future revenues are going to come from matter - then nVidia should be approached with a lot of caution until the questions about Fermi are settled.

  • Report this Comment On February 05, 2010, at 10:49 PM, baldheadeddork wrote:

    Okay, maybe this is like an undergrad asking Einstein if he's sure about that formula, but I think David's wrong on nVidia. Very wrong.

    No matter how good their books look, this is a company with substantial product problems on the near horizon. Their new Fermi line of graphics processors is running into massive problems as they try to start production, and even if they fix the yields this is going to be a chip that uses much more power and creates more heat than the new AMD 5xxx series. Mobile devices are the growth market for graphics chip makers and heat/power consumption are the top issues. (See here for recent tech article on nVidia's troubles with Fermi: http://www.semiaccurate.com/2010/01/17/nvidia-gf100-takes-28... )

    Their chipset business is going away, too. Making motherboard chipsets for AMD processors has been a major source of revenues for nVidia in the last decade, but AMD and Intel are both moving chipset functions to the CPU in all future designs.

    If the stock is priced correctly today is important, but if where future revenues are going to come from matter - then nVidia should be approached with a lot of caution until the questions about Fermi are settled.

  • Report this Comment On February 07, 2010, at 12:26 PM, TMFEditorsDesk wrote:

    @baldheadeddork,

    Interesting thoughts. Are you more bullish on AMD and Intel, then?

    Even though you disagree with David, I'm sure he's happy you compared him to Einstein!

    -Anand (TMFBomb)

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