Let's face it -- we humans are not the most logical sorts, in finance or in life. While many of us will gleefully drive across town to fill up our gas tank for $0.05 less per gallon, and save maybe $0.50 overall, we forget to contribute to our retirement plans -- which could make tens of thousands of dollars' worth of difference to our retirements.
Not that we're wrong to save $0.50. In fact, we should try to save money at every turn. After all, why spend more than you need to?
The value of sales
That same principle applies to our stock investing, yet many of us -- myself included -- often ignore it. Think of a company you're interested in buying. Let's use Coca-Cola as an example. Before you snap up shares, take some time to determine whether it's undervalued or overvalued. Why wouldn't you want to buy a good stock on sale?
For example, is the stock's price-to-earnings ratio below its historical norm? If so, that suggests an undervaluation. Another useful exercise is to compare any prospective investment with a major competitor. Let's use PepsiCo:
|
Coca-Cola |
PepsiCo |
|
|---|---|---|
|
Market cap |
$113 billion |
$106 billion |
|
P/E ratio |
21.6 |
22.1 |
|
Five-year P/E high/low |
36/20 |
40/22 |
|
Operating margin |
27.3% |
18.2% |
|
Five-year annual revenue growth rate |
5.6% |
7.4% |
|
Yield |
2.6% |
1.8% |
|
Five-year annual dividend growth rate |
11% |
15% |
These two competitors are actually rather close on most of these data points. I'd give the edge to PepsiCo for having a faster-growing dividend, along with faster-growing sales, but Coke demands some respect for its enormous operating margins.
Run this exercise with some other pairs of companies, and you'll often find more marked differences. Then read up on each pair to learn more about the things that the numbers don't tell you. Which company has the greatest competitive advantage? Which is developing the most promising new products or services? Which has a management team you trust more?
Price and value
In investing, it really all comes down to price and quality. You want to invest in high-quality, growing companies, and you want to buy into them at a good price -- not just any price.
To that end, here are a few companies that popped up when I ran a screen for outfits in the S&P 500 with dividend yields of at least 2% (because falling stock prices will prop up dividend yields), EBITDA margins of at least 20% (a sign that they're efficient operators), and P/E ratios of no more than 18 (which shows that they're cheap to reasonably priced):
|
Company |
Yield |
EBITDA Margin |
P/E |
|---|---|---|---|
|
Johnson & Johnson |
2.2% |
30.1% |
18 |
|
Pfizer |
4.3% |
42.3% |
16 |
|
Taiwan
Semiconductor |
2.7% |
64.8% |
14 |
|
Allstate |
2.2% |
21.8% |
9 |
|
Waste Management |
2.4% |
24.9% |
17 |
|
Cedar Fair |
6.7% |
39.7% |
13 |
|
Equity One |
4.4% |
63.9% |
12 |
Gather more candidates
You might want to research some of these companies further -- or perhaps you'd rather let us do most of the work. If so, I invite you to take a free trial subscription to our Motley Fool Inside Value service, which specializes in finding significantly undervalued companies with lots of growth potential. Even better, the service's picks are beating the market's returns by more than six percentage points. A free 30-day trial will give you full access to all current recommendations.
Here's to a happier portfolio!
This article was originally published on Dec. 13, 2006. It has been updated.
Longtime Fool contributor Selena Maranjian owns shares of Coca-Cola, PepsiCo, and Johnson & Johnson. For more about Selena, view her bio and her profile. Johnson & Johnson and Cedar Fair are Motley Fool Income Investor picks. Pfizer and Coca-Cola are Inside Value choices. The Motley Fool is Fools writing for Fools.
