The key to finding market-beating stock ideas is to turn over a lot of stones. That means examining multiple companies each month in the hopes of finding one that the market is mispricing.
To get after that goal, every member of our Motley Fool Global Gains research team is responsible for presenting one idea each month for the rest of the team to take a look at. While the ideas we like best end up becoming official Global Gains recommendations, there are a number of promising companies that we've passed on, waiting for either a better valuation or greater certainty regarding an aspect of their business. These companies, in other words, remain on our watch list, and I've listed two of them and the salient points regarding their investing theses below so you can add them to your watch list as well.
Canadian National Railway
Potential investment thesis: This well-positioned and best-in-class railroad is poised to outgrow current expectations thanks to its exposure to the metals, energy, and agricultural sectors as the world emerges from an economic recovery. Further, the railroad's exposure to the agricultural and mining sectors and to Pacific ports means that it should benefit from Asian demand for food and commodities. In an optimistic scenario, investors should expect 10% to 12% annual returns (2% of which is yield) with limited downside risk and exposure to the loonie.
Potential points of failure: Unfortunately, this is still not yet a super-attractive total return opportunity. Further, the railroad's volumes are still to some extent reliant on a rebound in the U.S. economy to stabilize auto, petrochemical, and paper goods shipping. The company's U.S. exposure -- to the extent that it has some -- is mostly to the industrial heartland (Chicago, Detroit, Duluth), which is declining.
What we're waiting for: As Warren Buffett reasoned with his acquisition of Burlington Northern, railroads are an attractive asset during times of economic uncertainty. That said, despite this company's attractive network -- and it is far superior to competitor Canadian Pacific
Potential investment thesis: The oil spill in the Gulf of Mexico has dinged the shares of energy prices across the board. Yet contract driller Seadrill has limited exposure to that area and has a much younger fleet relative to competitors such as Transocean
Potential points of failure: Despite the fact that the Gulf oil spill seems under control, its fallout could lead to tighter regulations of the offshore drilling industry. Seadrill's balance sheet is also heavily levered, which leaves little margin for error for shareholders, particularly if the company pursues acquisition opportunities in the sector such as Pride International
What we're waiting for: Seadrill's stock has recovered from its lows, which means the valuation relative to the industry risk and balance sheet profile is not as attractive as it once was. I think the threat of regulation will end up clearing up for the industry, so let's hope the stock drops before that fact becomes clear to other investors.
Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. Canadian National Railway is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.