Stock Tips That Will Make You Feel Smart

Do you like free stock tips? By the end of this article, I'll name one company that has a clear path to immense profitability -- without relying on unproven technology, precarious financing, or non-public information. In fact, this company has outlined its strategy quite clearly, and it has all the capability to carry it out, allowing investors like you and me to ride this stock to future wealth.

But before I reveal that stock, I'd like to show you why the traditional idea of the "stock tip" -- the notion that you can get rich quick by jumping on the next big thing before it takes off -- is heavily flawed. Such stock tips may initially make you feel clever, but they can often leave your portfolio in ruins.

Tips and traps
One of the worst investor prejudices is following the herd, or what social psychologist Robert Cialdini calls social proof. When faced with limited information, investors tend to buy what is popular. That's tremendously dangerous for your portfolio, as those who lived through the dot-com and housing bubbles know. You chase the market's darlings at your own peril, because their prices collapse faster than a boxer hit by a Tyson uppercut.

Take two currently popular stocks: For every Apple revolutionizing consumer electronics and building millionaires in the process, you have dozens of onetime market favorites such as Sirius XM (Nasdaq: SIRI  ) that have irrevocably destroyed shareholder capital. After nearly being left for dead in 2009, Sirius is a 35-bagger, but it's still down more than 80% in the last 10 years. If you thought the S&P had performed poorly over the last decade, it's got nothing on Sirius.

Investors in Microvision (Nasdaq: MVIS  ) have seen similar drops, and you don't have to cherry-pick prices at the peak of the dot-com bubble, when the stock was more than $60 per share. Now priced at less than $2 per share, this company makes miniature projectors, and it's been rumored to be involved in Apple's renovations of its iPhone and iPad. But the company has lost money every year for a solid decade. Some stock tip!

And investors piling into Chimera (NYSE: CIM  ) for its huge dividend (nearly 16%) are bound to see the share price decline, no matter how well-managed the company is. Since Chimera makes money on the interest rate spread, as rates rise, Chimera's profit will decline, and it will be forced to cut its payouts. That will send shares falling, but the market's short-term focus continues to makes this dividend look very tempting. This stock will be attractive until the day investors stampede to sell all at once.

And what would an article on stock tips be without a risky, cash-burning, clinical-stage biotech? That would be Arena Pharmaceuticals (Nasdaq: ARNA  ) , whose shares are off about 90% from their five-year high. The huge potential market for obesity drugs has kept investors interested in Arena, which is developing lorcaserin, a treatment for obesity. The Food and Drug Administration turned down the drug in October and requested further information, and the company continues to burn cash.

While investors piling into these stocks on a short-term basis may make money -- heck, anything's possible -- these stocks have a serious chance of declining permanently. In contrast, my stock tip has all kinds of chances for long-term success. The company doesn't have to establish a new product, relies on a proven business model, and is even profitable. That company is Yum! Brands (NYSE: YUM  ) .

The future is Yum!
There are so many tailwinds blowing in Yum!'s direction that it's hard to know where to begin. As the company behind restaurants such as KFC, Taco Bell, and Pizza Hut, Yum! offers investors an easy way to profit from international growth without the uncertainties of foreign accounting. And I'm not just talking about China; last year Yum! generated more than 40% of its operating profit there, compared to 38% for the U.S.

That type of opportunity has CEO David Novak crowing: "I wouldn't trade our long-term position in China with any consumer company in the world." There's also the international division, which includes the world's second most populous nation, India. Yum! is just getting started there.

The company has already indicated what we can expect in China; it predicts that the nation can support as many as 20,000 locations. There are almost 4,000 locations currently, so management expects to quintuple its presence there. Last year, the company opened some 500 restaurants in China -- an increase of 13% -- giving us some idea of the time frame for the build-out. At that rate, Yum! would reach 20,000 locations in 13 years.

To get a valuation, I ran a discounted cash flow analysis for the 13-year period. I assumed that the China unit grew income at 13% per year, the U.S. at 5%, and international at 8%, with a 3% terminal rate. With these assumptions, shares are worth about $62 at a discount rate of 10% -- indicating 30% upside to today's prices. That analysis doesn't take into account the possibility of higher same-store sales, commodity and wage inflation, or growth in India -- key factors affecting the company's fortunes. I just want to know that I'm in the right ballpark without particularly aggressive assumptions.

That valuation seems corroborated by Yum!'s P/E of 21. In comparison, McDonald's (NYSE: MCD  ) is also looking for growth in China and internationally, and it's priced at a reasonable 16 times earnings. McDonald's spinoff Chipotle (NYSE: CMG  ) -- and you should love spinoffs -- has taken tentative steps globally, and it trades at a much dearer 48 times. Chipotle's price predicts many years of phenomenal growth.

As with any company, there are challenges. The cost of its food inputs is rising as global commodities prices spike, and the company expects wages in China to rise by a midteens percent this year. Yum! will mitigate those concerns with modest price increases.

The company's success in expanding globally can be seen in its ability to rapidly raise its dividend over the last five years: Yum! has fattened its payout by 33% annually. That type of growth can't continue indefinitely, but its free cash flow payout ratio sits at just 35%, so there's still plenty of room for the company to increase its dividend.

Foolish bottom line
A nice dividend, massive global growth, the safety of an American company -- Yum! Brands seems to have it all. Add that to a share price that looks undervalued and you have the recipe for a winning stock. With its future prospects, Yum! is a stock tip that can truly make you feel smart.

If you're looking for one fully vetted stock investment in China, get the Motley Fool's free report, "This Stock Is Set to Soar as China's First Global Brand Emerges."

Jim Royal, Ph.D., does not own shares in any company mentioned here. Chipotle is a Motley Fool Rule Breakers pick. Apple is a Motley Fool Stock Advisor selection. Chipotle is a Motley Fool Hidden Gems pick. The Fool has written puts on Apple. The Fool owns shares of Apple, Chipotle, and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (8) | Recommend This Article (7)

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 07, 2011, at 2:54 PM, ItAintCool wrote:

    Jim Royal: Never misses an opportunity to name drop SIRI for more web hits. And yet despite the stock climbing to new highs over the past 2 years, making profits, increased free cash flow, increasing subscribers and improved credit ratings, he continues to find some way to put it in the negative.

    Gee Jim are you just upset because you might of told people to buy SIRI when it was 80% higher than it is now? Or are you upset because you missed the opportunity to buy the 35-bagger (and still increasing) opportunity it has become.

  • Report this Comment On February 07, 2011, at 3:08 PM, pete163 wrote:

    It look's as if he was he was burned in a shorting of Sirius XM. That was dum!

  • Report this Comment On February 07, 2011, at 3:19 PM, tjtoretire wrote:

    Ok, you made me a believer. I'm selling all my shares of Sirius that are up 75% within 6 months going into earnings next week which promise to be great....not to mention Sirius 2.0 coming later this year which will revolutinize satellite radio. NOT!!

  • Report this Comment On February 07, 2011, at 3:39 PM, siriuslyrick wrote:

    A Sirius dolt!

    Come on, Jim. The hyperbole ("irrevocably destroyed") isn't fooling anyone. Get with the times, or get left behind.

  • Report this Comment On February 07, 2011, at 3:44 PM, paul7777777 wrote:

    Jim Royal is totally wrong about Chimeira (CIM), even when rates go up it will still have a superior dividendyield over 99% of other stocks, so it is ideal for retired people and will not fall down much, moreover it has still a long way to go before it reaches the hight it had before the crisis.

    Reits have suffered much because of the crisis, but they have now high potentials because most of the writing off is already done and thet have still the highest dividendyields.

  • Report this Comment On February 07, 2011, at 3:45 PM, paul7777777 wrote:

    correction: they have still...

  • Report this Comment On February 08, 2011, at 10:32 AM, pondee619 wrote:

    fools still being fools:

    "Stock Tips That Will Make You Feel Smart

    By Jim Royal February 7, 2011

    "The future is Yum!"

    Yum! Brands Loses Flavor

    By Alyce Lomax February 3, 2011

    "...make Yum! Brands look a little less appetizing at the moment"

    I know, you aren't THE motley fool, you are THOSE/THESE motley foolS. Many different voices, stating many different opinions about the same subject. Don't like a story we wrote about a company, don't worry a conflicting one will be along any day now. Looking for advice on where to put your hard earned investment dollars, you will get the long and short on the same company here. WE CAN'T BE WRONG, because we take both sides. A cacophony of investment "advice".

    Yes, the future is YUM! whose shares look a little less appetizing at the moment.

    "What We Do

    The Motley Fool provides financial solutions for investors of every kind" Really? What solution is provided by the above "articles"

  • Report this Comment On February 08, 2011, at 4:53 PM, easyavenue wrote:

    JR,

    Well, it looks like you got us going on this one!

    You said:

    "Since Chimera makes money on the interest rate spread, as rates rise, Chimera's profit will decline, and it will be forced to cut its payouts."

    Don't you need to specify WHICH rising rates you mean b/c as consumer rates rise, as they are now, with short term rates steady (I'm not sure on that), CIM will have an even larger spread, and will make more $, and will give larger dividends. And the stock price should go up, not down.

    If you're referring to the Prime Lending Rate, at 0.25 I believe, the one the Gov. has said they will leave alone, like they have for some time now, then for what you say to come true you'll have to wait until they change their minds and raise it. Which no one expects them to do in the forseeable future. Yes?

    If I am right, then using CIM is a poor example, vaguely explained and unsupported by current facts. Therefore misleading? Or am I missing something? Please clarify. Thanks, JR!

    AE

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