At The Motley Fool, we write for all kinds of investors. Whether you've been investing for 50 years, five years, or five minutes, you're equally welcome here.
Of course, that necessarily means that some of the topics we write about are going to seem pretty elementary for some of our readers. Newcomers to investing, on the other hand, may find that even our most basic insights into investing are revelations. Today, I'm going to tackle a topic that longtime Fools will find painfully obvious. But obvious or not, it bears repeating.
The yin and yang of averages
The financial media are all the time mentioning "the average." The average stock does this. The S&P 500 Index does that. But think for a moment on what "the average" really means.
It's a composite, made up of good companies and bad. Profit makers and money losers. When we say that, on average, the stock market goes up 10% in value per year over long periods of time, that's true. And it's the reason why we advocate investing your long-term savings in the common stocks of public companies, as opposed to buying bonds or depositing your cash in a passbook savings account. Over the long term, stock investing is simply the best way to grow your money, ensure your retirement, and create wealth to hand down to your children and grandchildren.
But remember, we're talking about averages here. If 10% is the average return from the stock market, that means that for every company that exceeds the mark, there's another that falls short. When that happens, to push the average back up to the, well, average, it takes a steady outperformer like FedEx
You get the point. There are good and bad companies out there. Put 'em together and they create the average performance.
Ain't nothing wrong with being normal
Now there's nothing wrong with being average. If you've got better things to do with your time than grow your money to the maximum extent possible -- more power to you. You can do just fine as an investor, and never have to spend a minute of your life reading a balance sheet, by just saving regularly and investing your savings in an S&P index fund. Put your money in there day in and day out and let it quietly grow until you retire.
Other investors, however, simply are not willing to settle for average returns. If we know it's possible to do better than the average with a little bit of effort, that prospect lures us like the Siren's call. At the Motley Fool Stock Advisor newsletter, we're aiming to find and invest in only the "good" companies, to cut the losers whose dead weight drags all index funds -- and so many mutual funds -- back down to the average.
If you think Wall Street is in Lake Wobegon, you're all wet ...
... because there's no such thing as a fund composed entirely of companies that are all "better than average." Not in Garrison Keillor's fabled Minnesota town. Certainly not among the index funds. And not in actively managed mutual funds, either.
So we repeat: If you want to beat the average, you need to invest in the common stocks of individual companies. To avoid the bad ones. To pick only the good ones. To free yourself to rise above the mundane. But how, precisely, do you know which companies will do "better than average"?
And here's the answer. There's no guarantee. (Sorry, that's not what you wanted to hear, was it?)
But let me finish. There's no guarantee any company that appears to be a good investment will, in fact, succeed. Over the past three years, many investors have looked on Qualcomm
If a fine company like Qualcomm, one that has rewarded shareholders for over a decade, can take a multibillion-dollar hit with so little warning, then there are certainly no guarantees in this business. There are, however, ways to maximize your chances of success. And one way is to seek out companies that produce better-than-average numbers. Literally.
Here's your cheat sheet
But for that, you need to know what the average numbers are. To get those, click right here. You can improve your investing "percentage" -- the likelihood that any given stock will exceed the average -- by comparing your prospects to this list and investing in companies with one (or preferably more) superior metrics.
For example, right now the average S&P 500 company sports a return on equity of 20%. It's priced at 18 times free cash flow and 19 times trailing 12 months' earnings. It's expected to grow those earnings at just under 13%. (And for those of you punching away at your calculators, yes, the average company is therefore selling at a PEG of roughly 1.5, and so is, by traditional metrics, overpriced.) Finally, the average company pays a historically tiny 2% dividend.
So let's compare those numbers to a few prospective investments in, for example, the volatile for-profit education sector:
|S&P 500 Average||20%||19||18||13%||2%|
You'll find several lessons in the above chart. For one thing, it's clear that each of the companies in this sector operates more efficiently than the "average" company -- across the board, their returns on equity are simply stellar. They're also expected to post above-average growth.
At the same time, these companies' stock prices tend to reflect their quality. Divide their P/Es or their P/FCFs by their expected growth rates, and only Career Education and Corinthian pass the value investor's rule of thumb -- that the price ratio divided by growth should equal less than 1.0.
Of the two, I'd say that Career Education looks to be the better bet. While Corinthian has the lowest P/E of any company in its class, its earnings seem to overstate its actual cash profitability. In contrast, for Career Education, both the P/E and the P/FCF fall below its growth rate -- and that merits giving the company a closer look.
Motley Fool Stock Advisor seeks out companies whose prices do not reflect their superior businesses, faster growth, and, in many cases, their market-beating dividends. And to date, there's been some modest success. While the S&P 500 has gained 18% in value since the newsletter started a little over three years ago, Stock Advisor picks are up an average of 57%.
If you'd like to see how we do it, and take a look at some of the companies that have helped us to rack up these market-beating returns, you're in luck. Subscribe now and gain access to every issue we've ever printed and see every company we've ever recommended. You'll also receive, free, a copy of The Motley Fool's Blue-Chip Report 2005: 10 Monster Stocks for the Next Decade. Click here to learn more.
This article was originally published on April 20, 2005. It has been updated.