Why Aren't You Buying Stocks on Sale?

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Let's face it -- we humans are not the most logical sorts, in finance or in life. 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, but then 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
The same principle applies to stock investing, yet many of us -- myself included -- 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, ask yourself if the stock's price-to-earnings ratio (P/E) is 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	$138 billion	$115 billion
P/E	26	19
Five-year P/E high/low	36/18	36/18
EBITDA margin	30%	22%
Five-year annual revenue growth	7.6%	8.8%
Yield	2.3%	2.1%
Five-year annual dividend growth	11.3%	18.0%

The two competitors are actually rather close on many of these data points. PepsiCo sports the more attractive P/E and the heftier dividend increases, but Coca-Cola offers higher profit margins and a richer dividend yield.

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 the numbers don't tell you. Which company has the greater competitive advantage? Which one 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 large outfits with dividend yields of at least 2% (regular dividends will help investors cope with this volatile market), EBITDA margins of at least 20% (a sign of efficiency), and P/Es of no more than 20 (which suggests that they might be cheaply to reasonably priced):

Company	Yield	EBITDA Margin	P/E
GlaxoSmithKline (NYSE: GSK)	3.8%	38%	13
Telefonica SA (NYSE: TEF)	2.3%	39%	17
Wyeth (NYSE: WYE)	2.3%	32%	14
Gannett (NYSE: GCI)	3.8%	28%	9
First Marblehead (NYSE: FMD)	2.8%	73%	10
Fortune Brands (NYSE: FO)	2.0%	21%	17
Carnival (NYSE: CCL)	3.3%	30%	16

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 of our Motley Fool Inside Value service, which specializes in finding significantly undervalued companies with lots of growth potential. A free, 30-day trial will give you full access to all past issues and all the 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 and PepsiCo. Coca-Cola and First Marblehead are Motley Fool Inside Value recommendations. First Marblehead is also a Motley Fool Hidden Gems recommendation. GlaxoSmithKline is a Motley Fool Income Investor recommendation. The Motley Fool is Fools writing for Fools.