Let's face it -- we humans are not the most logical sorts, in finance or in life. While many of us will gleefully drive across town to fill up our gas tank for $0.05 less per gallon and save maybe $0.50 overall, we forget to contribute to our retirement plans -- which could make tens of thousands of dollars' worth of difference to our retirements.
Not that we're wrong to save $0.50. In fact, we should try to save money at every turn. After all, why spend more than you need to?
The value of sales
That same principle applies to stock investing, yet many of us -- myself included -- often ignore it. Think of a company you're interested in buying. Let's use Coca-Cola as an example. Before you snap up shares, take some time to determine whether it's undervalued or overvalued. Why wouldn't you want to buy a good stock on sale?
For example, ask yourself if the stock's price-to-earnings ratio (P/E) is below its historical norm. If so, that suggests an undervaluation. Another useful exercise is to compare any prospective investment with a major competitor. Let's use PepsiCo:
|
Coca-Cola |
PepsiCo |
|
|---|---|---|
|
Market cap |
$120 billion |
$109 billion |
|
P/E ratio |
24 |
20 |
|
Five-year P/E high/low |
36/19 |
36/19 |
|
EBITDA margin |
32.3% |
24.1% |
|
Five-year annual revenue growth rate |
7.2% |
8.4% |
|
Yield |
2.6% |
1.8% |
|
Five-year annual dividend growth rate |
16.4% |
15.1% |
The two competitors are actually rather close on many of these data points. I'd give the edge to PepsiCo for growing revenue at a faster clip and a marginally more attractive P/E ratio, but Coke demands some respect for its enormous margins and hefty dividend.
Run this exercise with some other pairs of companies and you'll often find more marked differences. Then read up on each pair to learn more about the things the numbers don't tell you. Which company has the greatest competitive advantage? Which is developing the most promising new products or services? Which has a management team you trust more?
Price and value
In investing, it really all comes down to price and quality. You want to invest in high-quality, growing companies, and you want to buy into them at a good price -- not just any price.
To that end, here are a few companies that popped up when I ran a screen for large outfits with dividend yields of at least 2% (because falling stock prices will prop up dividend yields), EBITDA margins of at least 20% (a sign that they're efficient operators), and P/E ratios of no more than 20 (which suggests that they might be cheap to reasonably priced):
|
Company |
Yield |
EBITDA margin |
P/E |
|---|---|---|---|
|
Petroleo Brasileiro |
2.5% |
32% |
9 |
|
TXU |
2.7% |
51% |
12 |
|
Automatic Data Processing |
2.1% |
23% |
16 |
|
General Mills |
2.5% |
22% |
19 |
|
UST |
4.1% |
51% |
19 |
|
Tribune |
2.2% |
26% |
15 |
|
Lee Enterprises |
2.6% |
28% |
16 |
Gather more candidates
You might want to research some of these companies further -- or perhaps you'd rather let us do most of the work. If so, I invite you to take a free trial subscription to our Motley Fool Inside Value service, which specializes in finding significantly undervalued companies with lots of growth potential. Even better, the service's picks are beating the market's returns by almost 7 percentage points. A free 30-day trial will give you full access to all past issues and all the current recommendations.
Here's to a happier portfolio!
This article was originally published on Dec. 13, 2006. It has been updated.
Longtime Fool contributor Selena Maranjian owns shares of Coca-Cola and PepsiCo. Coca-Cola is an Inside Value recommendation. Lee Enterprises is an Income Investor selection. TXU is a former Income Investor recommendation. For more about Selena, view her bio and her profile. The Motley Fool is Fools writing for Fools.
