"I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches -- representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all." -- Warren Buffett
In essence, Buffett is saying that we should carefully examine the financials and business dynamics of every stock before we invest, buying only those within our "circle of competence." If we've done our work correctly, we'll only need to make 20 bets during our lifetime.
Unfortunately, we sometimes get caught up in financial media hype, often selling at a loss. That's understandable: Growth stocks are fun to follow. However, you can strike a balance between growth and business fundamentals when choosing a stock. Here are three of them.
1. Baidu: Buy for its sustainable and competitive search business.
You might be worried that Baidu (NASDAQ: BIDU ) has lost about 18% of its value over the past year. And, the drop of more than 20 percentage points in its quarterly year-over-year revenue growth may have done little to ease your anxiety. Contributing to Baidu's decline has been Qihoo's growing market share and pricing power. But part of the problem is also that mobile advertising is less profitable.
But in summing up Baidu's prospects today, here is what I'd keep in mind. (1) Baidu is still growing at a staggering rate of more than 40% -- for comparison, Google (NASDAQ: GOOG ) is growing at 30%, yet its stock has returned 55% over the past year. (2) Despite increased competition in search, Baidu still dominates search with 70% of the market. (3) And while all advertising-based tech companies are struggling with mobile, Baidu seems most likely to dominate the Chinese field.
In this light, Baidu is still dominating tech company in China with a sustainable competitive advantage in search. Right now, it's just temporarily undervalued.
2. Tesla: Buy for CEO Elon Musk
Over the past year, Tesla (NASDAQ: TSLA ) stock has spiked 225%! If you think that's extraordinary, then just look at how much the company has grown its quarterly sales.
Of course, this isn't normal for most companies.
That's why the bears have set in. Naysayers point out that, before this quarter, (1) Tesla has never reported a quarterly profit. (2) Across the nation, dealers are suing the company for its company-owned store strategy. (3) Topping it all off, Tesla's $413 million in sales can't even begin to compare to Toyota (NYSE: TM ) Prius sales. In 2012, Toyota raked in $226 billion in revenue -- 546 times more than Tesla's.
So, why has such a "risky" company -- one with too idealistic an outlook for all the battles ahead of it -- made this list? Well, for that answer, I'll have to defer to Warren Buffett's right-hand man Charlie Munger:
Occasionally, you'll find a human being who's so talented that he can do things that ordinary skilled mortals can't. ... very rarely, you find a manager who's so good that you're wise to follow him into what looks like a mediocre business. -- 1994 speech to USC Business School
Founder and CEO Elon Musk, I think, is that kind of manager. Like Jack Welch, Musk has the "fanaticism" and "intelligence" that Munger admires. Most importantly, he's product-focused, demanding that Tesla be the best in every car category the company competes in. Already, Automobile Magazine and Motor Trend have both awarded Tesla's Model S Sedan as their pick for the 2013 Car of the Year.
3. LinkedIn: Buy for its stellar management AND sustainable, competitive advantage
LinkedIn's (NYSE: LNKD ) P/E stands at an astronomical 490. And with such a high multiple, any slip-up could send the company's stock price spiraling downward. One area that could mean the end LinkedIn's 75% run-up over the past year is mobile. Like Google and Facebook, the company will have the challenge of monetizing users as they switch from desktops to portable products.
Luckily, the company shows that it has plenty of room to grow. Currently, it has 225+ million members in its network out of a possible 700 million worldwide. As the company continues to add more than two new users a second, LinkedIn's growth and P/E seems reasonable.
Most importantly, LinkedIn's management is experienced and can capitalize on the market opportunity -- whether it be in display ads, premium subscriptions, or recruiting solutions. Of course, it all starts with the user. CEO Jeff Weiner knows that and is doing all he can to engage them better. Under his watch, LinkedIn has acquired the popular mobile newsreader app Pulse and rolled out new product features like Contacts to make the professional network more "sticky."
"Our favorite holding period is forever."
Which of these stocks is the most sure-fire path to profits? Well, that depends on which company (or companies) you understand -- which stock(s) fall within your "circle of competence." If you understand the economics behind social networks and professional recruiting, then LinkedIn may be the best buy; car mechanics, Tesla; search and all things digital, Baidu.
One thing you should keep in mind, though, is that not everyone can be Warren Buffett. But if you follow his advice, you can at least outsmart the financial media -- and maybe retire a bit early.
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