To determine the best stocks for new money, you need to know two things:
- How great is the company?
- What price is the market charging for that greatness?
The quality of a company is affected by management changes, competitive pressures, technological changes, regulation, labor unrest, demographic shifts, and so on. Yet a great company -- think 3M
Potential investors in great companies can focus on getting in at a good price and not worry too much about whether their initial investment thesis has shifted radically from month to month.
Contrast those first three with companies such as First Solar
What It Does
Significant Potential Threats
|3M||Consumer products across the spectrum, including Post-It Notes and Scotch tape.||The normal competitive threats any company faces.|
|UPS||Shipping via its vast logistical network.||Very dependent on the flow of goods through the economy, but replicating its network is costly.|
|Disney||Theme parks, movies, television (e.g., ABC and ESPN).||Alternative entertainment sources such as the Internet.|
|First Solar||Solar-energy products.||The viability of its products because of intense competition and innovation in a fast-changing industry.|
|JPMorgan Chase||Commercial and investment bank.||Regulation and the dangers of financial products that are difficult to evaluate from a risk standpoint.|
|AMD||Microprocessor manufacturer.||Intense competition as well as the threats from technological innovation ... for a company that has yet to prove sustained profitability.|
For the most part, the first three companies (3M, UPS, and Disney) rely on their strong brand names to thwart the competition. They certainly face competitive threats, but their businesses are well established and entrenched. The second set of three companies (First Solar, JPMorgan Chase, and AMD) don't just face the general competitive threats that capitalism throws a company's way ... they also face more specific near-term risks, such as rapid technological obsolescence.
Meanwhile, price can shift violently from month to month, or even hour to hour.
Now I'm going to make an obvious statement: As a result of quality movements to some extent and price movements to a large extent, the list of the best stocks for new money changes constantly.
It may be an obvious point, but most investors don't really pay attention to it. Let me briefly explain what I mean, and then I'll reveal a company our analysts have identified as one of the best stocks. Period.
Greatness isn't always a great idea
Investors sometimes get enamored with how great a company is -- and ignore the price. That's a mistake.
Imagine the house of your dreams. Would you pay $100,000 for it? How about $1 million? Or $10 million? It's the same dream house, but at some price point, you'll answer "No." Why? Because even your perfect house becomes a silly proposition at a high enough price.
You'll often hear investors extol the virtues of a company (20%-per-year growth! Steady earnings history! An amazing new product!) as evidence that the company is a bargain at any price. But a stock can be a great company and a terrible investment at the same time.
The first step to market domination
I can't stress enough how important price is to an investment's success, but I won't belabor the point: The first step to market domination is identifying great companies. The second step is buying them at great prices. That's how you beat the market. Period.
For the first step -- identifying great companies -- the folks on our Million Dollar Portfolio team pick their favorite stocks from among all of The Motley Fool's newsletter services. For example, insurance company Markel
But how do you determine an attractive price? You calculate an intrinsic value, which is your best estimate of the true value of a company, as opposed to its stock price. There are many ways to do this, including using multiples on earnings, cash flows, or book values. Our Million Dollar Portfolio analysts prefer the more time-intensive, but more thorough, method of using a discounted cash flow model.
After doing its due diligence and calculating Markel's intrinsic value, the team bought into Markel. Today, our team recommends buying below $370 a share. Since the stock currently sits below that point, at $345, this is a good time to do your own due diligence on Markel -- if you're comfortable with vetting insurance stocks.
To learn more about Million Dollar Portfolio, simply click here.
This article was originally published Feb. 13, 2010. It has been updated.
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
Anand Chokkavelu owns shares of Disney. Markel, Disney, and 3M are Motley Fool Inside Value picks. First Solar is a Motley Fool Rule Breakers recommendation. Walt Disney is a Motley Fool Stock Advisor selection. United Parcel Service is a Motley Fool Income Investor choice. The Fool owns shares of Markel and United Parcel Service and has a disclosure policy.