To determine the best stocks for new money, you need to know two things:
- How great is the company?
- What price is the market charging for that greatness?
The quality of a company is affected by management changes, competitive pressures, technological changes, regulation, labor unrest, demographic shifts, and so on. Yet a great company -- think McDonald's
Potential investors in great companies can focus on getting in at a good price, and not worry too much about whether their initial investment thesis has shifted radically from month to month.
Contrast those first three with companies such as Yingli Green Energy
|
Company |
What It Does |
Significant Potential Threats |
|---|---|---|
|
McDonald's |
Fast food. |
The normal competitive threats any company faces. |
|
Johnson & Johnson |
Health-care products across the spectrum, including Tylenol, Listerine, medical devices, and prescription drugs. |
Inability to replace patent expirations with new products in pipeline. |
|
Nike |
Athletic shoes and apparel. |
The normal competitive threats any company faces. |
|
Yingli Green Energy |
Solar company that makes photovoltaic (PV) products. |
The viability of its products because of intense competition and innovation in a fast-changing industry. |
|
Netflix |
Movies via DVD and the Internet. |
Losing market share in the transition from DVDs to online streaming. |
|
salesforce.com |
Customer relationship management via the cloud. |
Increasingly intense competition in a nascent technology. |
For the most part, the first three companies (McDonald's, J&J, and Nike) rely on their strong brand names to thwart the competition. They certainly face competitive threats, but their businesses are well-established and entrenched.
The second set of three companies (Yingli Green Energy, Netflix, and salesforce.com) don't just face the general competitive threats that capitalism throws a company's way, but also more specific near-term risks, such as rapid technological obsolescence.
Meanwhile, price can shift violently from month to month, or even hour to hour.
Now I'm going to make an obvious statement: As a result of quality movements to some extent, and price movements to a large extent, the list of the best stocks for new money changes constantly.
It may be an obvious point, but most investors don't really pay attention to it. Let me briefly explain what I mean, and then I'll reveal a company our analysts have identified as one of the best stocks. Period.
Greatness isn't always a great idea
Investors sometimes get enamored of how great a company is -- and ignore the price. That's a mistake.
Imagine the house of your dreams. Would you pay $100,000 for it? How about $1 million? Or $10 million? It's the same dream house, but at some price point, you'll answer "no." Why? Because even your perfect house becomes a silly proposition at a high enough price.
You'll often hear investors extol the virtues of a company (20%-per-year growth! Steady earnings history! An amazing new product!) as evidence that the company is a bargain at any price. But a stock can be a great company and a terrible investment at the same time.
The first step to market domination
I can't stress enough how important price is to an investment's success, but I won't belabor the point: The first step to market domination is identifying great companies. The second step is buying them at great prices. That's how you beat the market. Period.
For the first step -- identifying great companies -- the folks on our Million Dollar Portfolio team pick their favorite stocks from among all of The Motley Fool's newsletter services. For example, insurance company Markel is one they've identified. For an idea of its reputation among value investors, consider that it's frequently described as a mini-version of Warren Buffett's empire.
But how do you determine an attractive price? You calculate an intrinsic value, which is your best estimate of the true value of a company, as opposed to its stock price. There are many ways to do this, including using multiples on earnings, cash flows, or book values. Our Million Dollar Portfolio analysts prefer the more time-intensive, but more thorough, method of using a discounted cash flow model.
After doing its due diligence and calculating Markel's intrinsic value, the team bought into Markel. Today, our team recommends buying below $370 a share. Since the stock currently sits below that point, at $360, this is a good time to do your own due diligence on Markel -- if you're comfortable with vetting insurance stocks.
To learn more about Million Dollar Portfolio and to get "Motley Fool Top Picks & Perspectives 2011," a new free report with stock recommendations and portfolio guidance for the year ahead, simply enter your email address in the box below.
