Top Stocks to Buy Today

"The stock market is filled with individuals who know the price of everything, but the value of nothing."
-- Philip Fisher

Despite the recent gains in the market, current economic data suggests we shouldn't expect a full recovery anytime too soon. So it may be fair to ask ourselves: How can we avoid the mistakes that got us here, and how can we find the top stocks to buy today?

Consider this
The mistakes that led to this downturn are reminiscent of the speculative frenzy known as the Dutch Tulip Craze. In 1636, Dutch citizens found themselves caught up in a tulip rampage, fueling skyrocketing orders and prices that grew by as much as 100% per week.

Eventually, one tulip bulb was selling for the equivalent of thousands of modern-day dollars! The market became overbought, and the frenzy bottomed. By 1637, the price of tulips was less than 1% of what it had been before the crash. Value was an afterthought to the tulip "day traders" who sought to profit from irrationally soaring prices.

Quickly fast-forward to the dot-com bust. The growth of Internet companies and an overinvestment in information technology caused the Nasdaq to rise more than 600% from 1994 to early 2000. If you were alive or breathing in the last 10 years, surely you remember what happened next:

  • In 18 short months, approximately $5 trillion was wiped out from the value of technology stocks.
  • Silicon Valley trendsetters such as NVIDIA (Nasdaq: NVDA  ) and Advanced Micro Devices (NYSE: AMD  ) experienced price depreciations of more than 80%.

As with the tulips, it seemed as though everyone was confident in the price of the next "big" stock. The classic example of the overhyped company of the time was Pets.com. After trading for more than $14 per share, it liquidated in less than 270 days at $0.22 per share. Everyone supposedly knew the right price -- but what was the value?

OK, let's talk 2008
Call last year what you want. The housing horror. The derivative debacle. The commodity crisis. The securitization scare. There are too many explanations for the collapse to isolate only one aspect.

For the sake of argument, I'll arbitrarily choose crude oil to illustrate my point. The Commodity Futures Trading Commission recently announced ithat t will release a report suggesting that speculators played a role in driving last year's wild swings in oil prices, which spiked at $145 a barrel for crude in July before collapsing to $33 a barrel by December, representing a 77% decline in value over a six-month period.

Diamond Offshore Drilling (NYSE: DO  ) and Nabors Industries (NYSE: NBR  ) , two of the larger oil and gas drilling management and service providers, lost more than 60% of their value between 2008 and early 2009 ... and have gone on to reap substantial gains over the last year, more than making up for their losses along with the recent crude oil rally. I don't mean to sound repetitive here, but from these numbers, it appears that many investors didn't evaluate these companies' competitive positions but were instead making bets on oil prices.

What, if anything, have we learned?
We can be certain that there will always be ups and downs, booms and busts, good years and bad. So what can we do? One philosophy is to invest in companies with great competitive advantages, clean balance sheets, and a history of success in their given industries.

For example, Rackspace Hosting (NYSE: RAX  ) , an Internet software and technology company, has emerged as a leader in providing services for small and medium-size enterprises. They've also managed to make a name for themselves in the nascent cloud computing market. With a total debt-to-capital ratio of 34%, fantastic gross margins, and the ability to consistently deliver double-digit returns on equity, Rackspace would certainly seem like a good investment. But at more than 60 times future earnings, does it actually provide you with much value today?

Similarly, you might be excited by the many prospects for Amazon.com (Nasdaq: AMZN  ) . Having already established themselves as the leading online retailer, Amazon.com has gotten involved in everything from cloud computing to the new e-book industry. Accordingly, many investors have jumped on the bandwagon -- and the stock has reaped the benefits, more than doubling over the past year.

But it's trading at more than 50 times its future earnings and more than 15 times its book value. Does that provide value to someone buying shares today?

It's hard to know the answers. That's why we focus not only on exciting companies, but on ones that are exuding value, as well.

Here's a place to start
In both bear and bull markets, value investing has provided people with a logical and methodical approach to investing. The general ideas: Don't speculate on questionable growth potential or companies with debatable revenue streams. Look at companies that may be trading well below their intrinsic value for unfounded reasons, seem cheap compared with their industry, and have strong records of returning capital to their shareholders.

Here a just a few companies that fit the bill right now:

Company

% Below 12-Month High

Price-to-Earnings Ratio

Return on Equity

China Mobile Limited

23%

10.9

26%

Lockheed Martin (NYSE: LMT  )

13%

9.9

47%

K-V Pharmaceutical

33%

2.8

22.6%

Data from Capital IQ as of Dec. 23, 2009.

Granted, in some cases these companies' P/Es are artificially low based on last year's higher earnings. But even if earnings decline, they're still pretty cheap.

More ideas
Our Motley Fool Inside Value team seeks out companies that not only have great competitive advantage and growth opportunities (Open Table and Las Vegas Sands, for example), but that also trade at bargain prices. If you're looking for more cheap stock ideas, you can click here for a free stock report.

This article was originally published Aug. 7, 2009. It has been updated.

Fool contributor Jordan DiPietro doesn't own any of the shares mentioned above. Rackspace Hosting is a Motley Fool Rule Breakers selection. Amazon.com and NVIDIA are Stock Advisor recommendations. The Fool's disclosure policy recently redeemed a coupon and received one free burrito. Now that's value.


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