Most Fools are fans of having long-term relationships with their stocks. This lets us thumb our noses at the mostly short-term-focused investors on Wall Street and take advantage of things like time arbitrage and the compounding magic of dividends.
We don't, however, marry our stocks. As much as we may like our stocks, we still need to maintain enough distance that we're able to part ways if something bad happens at the company, other investors are offering us such a high price that it'd be silly not to sell, or ...
We find something better
To be sure, the grass isn't always greener when it comes to investments. Even when it may appear to be somewhat greener, costs like trading fees and taxes may make it not worthwhile to change horses.
But since we don't have an exclusive relationship with the stocks in our portfolio, we can feel free to shop around and see what else is out there, just in case there is a dream floating around that you don't own. For me, that means finding a stock with:
- A forward price-to-earnings ratio below 14;
- A dividend above 2.5%;
- A debt-to-equity ratio below 100%;
- A return on unlevered net tangible equity (a measure I borrowed from Warren Buffett) above 20%;
- A business that I understand.
The list that I came up with includes a fair number of stocks that I already own -- AT&T and Abbott Labs, for instance -- but since I'm looking for fair maidens that I'm not already well acquainted with, I removed those from consideration. What follows are three of my favorites from the group.
Defense contractors have been blinking on my investment radar for a while now. Passed over by many investors thanks to concerns over the defense budget, many of these stocks have ended up with compelling valuations. Just last month I highlighted that noted value investor Tweedy, Browne had taken up a position in Lockheed Martin
However, the list of "dream stock" requirements above seriously narrows the number of defense contractors that I have to choose from, and, with a debt-to-equity ratio of 135%, Lockheed doesn't make the cut.
In fact, the only two that did make the list were Raytheon and Northrop Grumman. Choosing between them was tough. On the basis of forward P/E, Northrop was slightly cheaper, though Raytheon's returns on unlevered tangible equity were much better. Debt-to-equity is nearly the same for both companies, as is the dividend yield.
So what tipped the scales in favor of Raytheon? I like the business mix at Raytheon, which is a bit more focused on information and surveillance systems, versus the exposure to big projects like planes and ships at Northrop. And while I don't focus on insider ownership as much as some Fools, I do like the fact that Raytheon's CEO owns $44 million worth of company stock. And finally, the Motley Fool CAPS community gives Raytheon the edge with a four-star rating versus Northrop's three.
People- and knowledge-based businesses can be tough because it's difficult to create a competitive moat and there's less opportunity for operating leverage. However, when it's done right, it can end up a virtual empire. I put both Accenture and Goldman Sachs into this camp.
Willis Group is another that I put here. I don't think the phrase "insurance brokerage" conveys the full extent of why I like Willis' business, so I prefer to think of it more as a "risk management consultancy," helping clients navigate the wooly world of insurance and making sure they're covered for the specific risks that they're exposed to.
Willis' stock currently trades at a lower multiple than direct competitors Aon and Marsh & McLennan
Overall, though, I like Willis' business, its stock is attractively priced, and it pays you a decent dividend. If you liked Raytheon's CEO's ownership stake, then you'll love the $148 million in Willis stock that CEO Joseph Plumeri owns.
Since I'm a fan of dividends and the first two picks were on the low end in terms of yield, I wanted a bit more payout in the final spot. And big pharma is certainly the place to find that these days.
To be sure, there's a reason for that. Big pharma companies are facing a nasty patent cliff that will slash revenue as big drugs lose their patent protection. Pfizer
But the stocks have already been knocked down significantly from the patent-expiration fears and investors have been able to pick up juicy dividends and may also benefit from big buyback programs. As for the future, it's no easier to predict drug approvals for these giants than it is to wager on the biopharma small fries. However, like Willis above, AstraZeneca and the other big pharma companies are largely knowledge-based businesses with a lot of talented scientists putting a lot of irons in the fire. Could it really be that the well will run dry after current drugs go off-patent?
Whether or not you're ready to buy, I think all three of these stocks deserve to be on your Foolish watchlist. You can add them easily by clicking on Raytheon, Willis Group, and AstraZeneca. Don't have a watchlist yet? Set one up now -- you'll get timely updates and a free copy of the special report "Six Stocks to Watch from David and Tom Gardner."