A Conviction Buy Is a Rare and Beautiful Thing

This article features J.M. Smucker Co., Reynolds American, and The Buckle. Michael Hooper owns shares of The Buckle, Reynolds American, and J.M. Smucker. The Motley Fool recommends The Buckle. The Motley Fool owns shares of The Buckle.

A conviction buy is a rare thing. This is a moment when an investor is absolutely convinced he is correct on his analysis of a stock. He knows he won't lose on his trade and probably will make an outstanding return.

Very few professional analysts ever use the term "conviction buy." They are more likely to say "buy," or "overweight." I've been a stock investor for 20 years, but only experienced a handful of "Conviction Buys." To make a conviction buy, you must first have a list of want-to-own stocks and a pile of cash available. Watch stocks daily. Fear and greed will create buying opportunities.

I am offering three stocks that should be on your wish list: J.M. Smucker Co. (SJM 0.72%), Reynolds American (RAI) and The Buckle (BKE -2.42%). These are outstanding companies with strong balance sheets and higher profit margins than their peers. Here is a table comparing these companies to their peers using fundamental metrics:

Source: Charles Schwab Research and Yahoo Finance.

Jelly, tobacco and teen fashion
Smucker has a superior profit margin and lower debt/capital ratio than Kellogg. The lower the debt-to-capital ratio, the better. Smucker owns Folgers coffee and many staples such as Smucker's jelly --  food products that have maintained their popularity over time. Smucker is a family run business that dates back over 100 years. Family members want the stock to perform well and return increasing levels of dividends to shareholders. Investors like us get to go along for the ride.

Michael Hooper owns shares of The Buckle, Reynolds American, and J.M. Smucker. The Motley Fool recommends The Buckle. The Motley Fool owns shares of The Buckle.

Reynolds American has a slightly higher net profit margin than Altria Group and Lorillard Reynolds also has a lower debt/capital ratio. Tobacco companies have huge profit margins, but struggle to grow due to increasing awareness of the health risks of smoking. Reynolds has developed some interesting niches, including its Santa Fe Natural Tobacco Co.  and R.J. Reynolds Vapor Company. I've noticed several friends smoking Santa Fe Natural Tobacco cigarettes. They say Santa Fe cigarettes taste more natural than traditional cigarettes. The vapor company was created last year to bring a new electronic cigarette to market.

The Buckle is a teen fashion leader. The company has a huge 14.47% net profit margin, beating Abercrombie & Fitch's 5.03% margin and The Gap's 8% margin. The Buckle also has no debt. Its same-store sales have been growing. For the past four years, The Buckle has paid out a special dividend. Last year the special dividend was about 10% of the stock price at the time. The Buckle has had a solid year so far. I expect it to pay another special dividend this fall.

The bottom line
When Warren Buffett knew he was right about a stock, he wasn't afraid to go in deep. In his early days, a conviction buy could represent one-third of his portfolio. If he was right -- and usually he was -- that big holding really boosted his returns. On Sept. 19, Buffett told CNBC stocks "were very cheap five years ago, ridiculously cheap, and that has been corrected. They're probably more or less fairly priced now... We're having a hard time finding things to buy."

Smucker, Reynolds American and The Buckle need a pull-back before they are a conviction buy, but keep them on your wish list. The patient investor watches and waits for the right opportunity to make a conviction buy.  This may take months of patient observation, reading and analysis. When the investor knows the odds are likely in his favor, he invests with conviction. He isn't afraid to go in deep because he knows the rewards will likely be outstanding.