7 Strong Stocks for Our Portfolio

This article is part of our Rising Star Portfolios Series.

Welcome back to the "multivitamin" portfolio -- a diversified, well-balanced, complete, one-stop portfolio for all your investing needs. It also helps ward off the common cold.

In my last article, I built an airtight case for starting off the port with an anchor stock -- one that, if my investing thesis is correct, will contribute steady returns for years to come. These are dividend-paying, financially sound, strong consumer brands that act as bear-market protectors and return accelerators. The article is worth a read if you missed it.

My screen produced a list of 57 candidates, and now it's time to thin the herd. For starters, we'll cull out what I couldn't screen for: companies that don't produce strong, recognizable consumer brands or pharmaceuticals.

Beyond that, it's quite easy for me to eliminate even famous companies where I don't perceive a consumer moat. For instance, ExxonMobil has one of the world's most recognizable brand names, but most gasoline consumers aren't particularly loyal and will gladly drive farther down the street to save a few cents a gallon. The company definitely has some competitive advantages, but fierce consumer loyalty is not one of them. On the other hand, most soft-drink, um, drinkers are different. Coca-Cola aficionados will drive farther down the street to pay a few cents more for their beloved sugar water.

Long-lasting brands
So after eliminating a few more candidates, we're down to our final eight. I guarantee you, 50 years is a long time for a company to survive. Many of these guys have already been around a lot longer than that, and it's easy to envision most of them being around for at least another 50:

Company	Founded	Brands	Dividend Yield
Microsoft (Nasdaq: MSFT  )	1975	Windows, Xbox	2.4%
Procter & Gamble (NYSE: PG  )	1837	Tide, Crest, Pampers	3.0%
Coca-Cola (NYSE: KO  )	1886	Coke, Diet Coke	2.8%
PepsiCo (NYSE: PEP  )	1898	Pepsi, Doritos	3.0%
McDonald's (NYSE: MCD  )	1948	McDonald's	3.1%
Abbott Labs (NYSE: ABT  )	1888	Similac, Ensure	3.7%
3M (NYSE: MMM  )	1902	Post-it, Scotch	2.4%
Nike	1964	Nike	1.3%

All of these companies fit the El Dorado mold of either being in the pharmaceutical industry or selling consumer products that inspire customer loyalty. I must say I wrestled with the decision to include Microsoft. I can't honestly say how much of its stranglehold in computer operating systems and business software is a result of consumer loyalty and how much is its near-monopoly status. It's pretty simple: If you're going to buy a PC, you're going to get Windows. No matter how you slice it, however, Mr. Softy is able to achieve pricing power because of its dominance, and that's what we're really looking for with this requirement.

Finally, because dividend reinvestment is such an important part of our strategy, I'm going to eliminate Nike due to its low yield compared to the others. So let's pop the remaining candidates into a table along with some of their more important metrics.

Company	Market Cap (millions)	Forward P/E	EV/FCF (TTM)	ROE	ROC	Net Margin	FCF Margin
Microsoft	224,754	10.5	10.4	46.7	32.6	31.3	28.0
Procter & Gamble	180,072	15.8	19.7	17.0	10.1	13.9	13.6
Coca-Cola	146,102	16.8	33.7	29.2	15.2	23.6	13.5
PepsiCo	102,444	14.5	33.2	36.3	16.5	12.1	6.88
McDonald's	83,306	16.2	25.7	36.7	18.2	20.6	15.1
Abbott Labs	75,096	10.6	20.3	22.1	11.6	13.9	13.1
3M	61,649	14.3	20.8	29.4	18.3	15.7	11.4

Source: Capital IQ, a division of Standard & Poor's. EV/FCF (TTM) = Enterprise value / free cash flow ratio for trailing 12 months. ROE = return on equity. ROC = return on capital.

What jumps out at us here? For starters, look how much easier a software company like Microsoft has it than makers of physical products like Procter & Gamble and 3M. The net margins tell the story; Microsoft earns a profit of $0.31 for every dollar in revenue it collects. Because of the extra expenses, the latter two take in $0.14 or $0.15 per dollar of revenue. Not bad, but Mr. Softy is twice as efficient.

Microsoft shines in a couple of other key metrics: return on equity and return on capital. It also seems a notch better than the other companies when we look at earnings and free cash flow multiples. By the numbers in that chart, then, Bill Gates' Redmond bunch really stands out – but that's just a quick glance and there are other things to consider.

And that's where we'll pick it up next time. We'll look a little deeper into the numbers and talk about competitive positions. If you have thoughts on any of the finalists, please drop by our discussion board and sound off!