Here's the picture: You've been keeping up with a list of stocks via your Foolish watchlist (more on that later) and you decide that it may be a good time to put a little more of your cash to work now that the S&P 500 has fallen considerably from its mid-February high.
But when it comes down to pulling the trigger, how do you choose which stock gets the nod?
Having the following four pieces of information close at hand can help you make that call.
1. Expected returns. This is the elephant gun in the mix because it combines four key pieces of the investment puzzle -- earnings growth, valuation, dividends, and share count -- to give you an expected return on the stock in question. In the process of determining expected returns, I think the best strategy is to find a range of possible outcomes, but for the purposes of making the final buy decision, have your mid-case (most likely) scenario at hand.
Curious how to determine expected returns for the companies on your watchlist? I've walked through the process for both Sysco (NYSE: SYY) and Raytheon (NYSE: RTN).
2. Insider ownership. Motley Fool co-founder Tom Gardner once said that if he had to choose a single metric to judge a stock on, it'd be insider ownership. Fortunately, we're not limited to just one metric, but Tom's bold statement underscores the importance of this one. Put simply, a CEO who owns a hefty amount of the company's stock very likely has incentives that are aligned with you and the other investors.
With a company like Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) -- where Warren Buffett owns roughly 20% of the company (worth a cool $50 billion) -- the ownership connection jumps out as obvious. That size of a percentage stake, however, is more common among smaller companies -- CEO Maryjo Cohen, for instance, owns nearly 25% of National Presto Industries (NYSE: NPK).
For larger companies, a CEO's incentives can still be aligned with yours without a huge percentage ownership. Lloyd Blankfein over at Goldman Sachs (NYSE: GS) owns less than 0.5% of the company, but that still translates to more than $300 million in stock -- and that doesn't include stock options or restricted stock.
3. The Buffett ratio. There are many ways to measure the efficiency and profitability of a company, but I've fallen for this measure. Referred to by Buffett as "earnings on unleveraged net tangible assets" in his Berkshire shareholder letter this year, this is a measure similar to return on equity or return on invested capital.
Why this particular ratio? Because it emphasizes returns on all of the capital that the company is using -- rather than just the equity -- but it strips out the company's intangible assets, which is generally more of an accounting artifact than useful measure.
4. The special sauce. Call it a competitive advantage, call it a moat, call it whatever you want -- this is what gives the company in question a leg up over its competition. Moats come in all shapes and sizes -- some wide and nearly impossible to breach, while some are pretty shallow -- but if you're planning to buy into a company, you ought to know what makes it special.
For example, in the case of Coca-Cola (NYSE: KO) it has -- at least according to brand expert Interbrand -- the most valuable brand in the entire world. That is a seriously formidable moat for any upstart cola-maker that wants to try to unseat the king.
Why four?
Four isn't a magic number unless you're counting letters in cuss words, so you can feel free to play around with my list to suit your tastes. However, the point is to keep the list short and simple and avoid information overload. After all, the idea is for this to be a quick reference when it's time to buy, not an exhaustive rehashing of all of your diligent research.
Back to that watchlist
Having a watchlist where you can keep up with what's going on with the stocks on your radar is essential. The metrics above aren't written in stone and having the targeted coverage that the Fool's watchlist provides can keep you up to date on any changes. You can add companies from this article to your watchlist by clicking the "+" icons above, or you can start up a fresh watchlist and add whatever stocks you want.
As an added bonus, by setting up a watchlist you'll get access to a special report from our founding Fools, "6 Stocks to Watch from David and Tom Gardner."
