The Value of a Deep Bench

There's more to the game than what's out on the court
I don't pay enough attention to the roundball powers these days to offer much in the way of predictions about what's going to happen out there on the court, but I do feel safe in offering this one: Teams with deep benches will have an advantage.

This is pretty simple to understand. If you've got a deep stable of interchangeable speedsters, you can run the other team's legs off. If you've got a second or third big man, you can sub in a fresh one every time. The key, of course, is knowing the capabilities of your second-stringers and using them when they offer an advantage.

The importance of a good second string
I think there's a similar phenomenon in investing. Stock pickers, especially value investors, who keep a deep bench are primed for success in the markets. They're more flexible when the market makes a run against the weakness in their first squad, because they've got fresh subs waiting in the wings. Oil patch burning you up? Check on your retailers. Consumer sentiment spanking your mall rats? Look at your consumer staples. Anything cheap and ready to run? Maybe it's time those sideliners got into the action.

I first got an inkling of the value of a deep bench when I began reading about Warren Buffett and the sheer breadth of companies he kept tabs on. Here's a man who spent (and still spends, as far as I know) a huge amount of his time reading about any company whose filings he could get his hands on. It soon became obvious to me that Buffett didn't succeed just because he could do discounted cash flows in his head or because he's got a knack for picking good management. He also succeeded because he had a very deep bench -- maybe most of the market.

Buffett gets to know the players ahead of time. When he made his legendary purchase of then-hated Coca-Cola, Buffett knew what Coke was worth. He knew that New Coke was a recoverable disaster. When the market gave him the chance, he moved the company off the bench, and it didn't take long for it to light up the investing scorecard.

Gathering some pine-riders
Creating your own deep bench need not be as all-consuming as it appears to be for Buffett, or even my Fool colleague Stephen Simpson, who watches about a thousand stocks. Thankfully, the Internet makes our task a lot easier.

First, come up with a list of companies you'd love to have on your team. I mean the best of the best. My own includes everything from Apple to Waste Management. For now, don't discriminate by price. Next, keep it all together in a spreadsheet into which you can easily plug in select bits of information, which will make it easier to automate some of your valuation processes. The goal isn't to get a definitive valuation -- it's to alert you to potential opportunities. (You can do the hard math later to see whether things really do add up.) In order to trigger your value meter, something as simple as comparing the current P/E to the typical market multiple may be sufficient. For companies with earnings that wriggle greatly, price-to-book or enterprise value-to-revenue comparisons might be better.

Finally, try to use a quick-and-dirty cash flow valuation. I try to keep my bench stocked with about 100 great companies. Once every other month, I try to peek at their latest earnings and cash flows. Then, with the help of another spreadsheet, I pop out a very rudimentary discounted free cash flow valuation and compare it to the current price. If things look interesting, I know it's time to move that player to the head of the bench and dig in to see whether it's really ready to enter the big time. This weekend, it was time to play catch-up, and here are how 10 of those companies fare by my estimates.

As is often the case, many of the biggest names are among the most overvalued. But companies I'd forgotten to watch, like sinking Gannett and UST, or surging McDonald's and Target, are definitely worth a closer look.

The clock runs out
A deep bench is one of the most fundamental tools for a budding value investor. By keeping in touch with a stable of companies you know and trust, you'll sharpen your analytical skills. Better yet, you'll be a step ahead should the market offer you a good opportunity to put one of those companies into play.

Coca-Cola is an Inside Value recommendation, while Starbucks is a Motley Fool Stock Advisor pick.

Philip Durell knows the value of a good bench. That's why Motley Fool Inside Value features a monthly Watch List, as well as boards dedicated to discussion of other potential superstars. A free one-month guest pass will give you a look at the entire team.

Seth Jayson figures playing a game of HORSE would be more fun than keeping up with his watch list, but it wouldn't pay as well. At the time of publication, he had shares of UST, but no position in any other stock mentioned. View his stock holdings and Fool profile here . Fool rules are here .