To determine the best stocks for new money, you need to know two things:
1. How great is the company?
2. What price is the market charging for that greatness?
The quality of a company is affected by management changes, competitive pressures, technological changes, regulation, labor unrest, demographic shifts, etc., etc., etc. Yet, a great company -- think Johnson & Johnson
Potential investors in great companies can focus on getting in at a good price and not worry too much about whether their initial investment thesis has shifted radically from month to month.
Contrast those first three with companies like Yingli Green Energy
|
Company |
What it does |
Significant Potential Threats |
|---|---|---|
|
Johnson & Johnson |
Health-care products across the spectrum, including Tylenol, Listerine, medical devices and prescription drugs. |
Inability to replace patent expirations with new products in pipeline. |
|
3M |
Consumer products across the spectrum, including Post-It Notes and Scotch tape. |
The normal competitive threats any company faces. |
|
Nike |
Athletic shoes and apparel. |
The normal competitive threats any company faces. |
|
Yingli Green Energy |
Solar company that makes photovoltaic (PV) products. |
The viability of its products because of intense competition and innovation in a fast-changing industry. |
|
Bank of America |
Bank. |
Regulation and the dangers of financial products that are difficult to evaluate from a risk standpoint. |
|
AMD |
Microprocessor manufacturer. |
Intense competition as well as the threats from technological innovation ... for a company that has yet to prove sustained profitability. |
For the most part, the first three companies (J&J, 3M, and Nike) rely on their strong brand names to thwart the competition. They certainly face competitive threats, but their businesses are well-established and entrenched. The second set of three companies (Yingli, Bank of America, and AMD) don't just face the general competitive threats that capitalism throws a company's way ... they face more specific near-term risks (e.g., rapid technological obsolescence and government regulation).
Meanwhile, price can shift violently from month to month or even hour to hour.
Now I'm going to make an obvious statement: As a result of quality movements to some extent and price movements to a large extent, the list of the best stocks for new money changes constantly.
It may be obvious, but most investors don't really pay attention to it. Let me briefly explain what I mean and then I'll reveal the companies our analysts identified as the best stocks. Period.
Greatness isn't always a great idea
Investors sometimes get enamored by how great a company is -- and ignore the price. It's a mistake.
Imagine the house of your dreams. Would you pay $100,000 for it? How about $1 million? $10 million? It's the same dream house at every price point, but at some price point, you'll answer "No." Why? Because even your perfect house becomes a silly proposition at a high enough price.
You'll often hear investors extol the virtues of a company -- 20%-a-year growth! Steady earnings history! An amazing new product! -- as evidence the company is a bargain at any price. But a stock can be a great company and a terrible investment at the same time.
The first step to market domination
I can't stress enough how important price is to an investment's success, but I won't belabor the point: The first step to market domination is identifying great companies. The second step is buying them at great prices. That's how you beat the market. Period.
So what are some of the best companies out there? I asked a few of our top analysts, and here's what they said.
|
Analyst |
Favorite Stock |
Reason |
|---|---|---|
|
Matt Koppenheffer |
Visa |
A powerful network that allows for high margins without exposure to consumer defaults (similarly to MasterCard |
|
Tim Beyers |
Netflix |
Underrated ability to provide value to its customers as its business model adapts to technology changes. |
|
Morgan Housel |
Costco |
A membership-fee model that allows Costco to vex the competition by slashing its prices to breakeven. |
|
Alex Dumortier, CFA |
S&P 500 ETF |
A diversified bet on America. |
|
Toby Shute |
Graco |
The industrial play gets shockingly consistent and shockingly high returns on equity. |
Are these the best stocks to buy now? Maybe -- if they meet your standards and are selling for an attractive price.
How do you determine an attractive price? The answer is calculating an intrinsic value, which is your best estimate of the true value of a company (as opposed to its stock price). There are many ways to do this. Using multiples on earnings, cash flows, or book values are common. Our market-beating Inside Value investing service prefers the more time-intensive, but more thorough, method of using a discounted cash flow model.
After doing its due diligence and calculating Costco's intrinsic value, the team recommended the company to its members back in August. Its stock has run up since then, but the team still admires Costco's business model and recommends buying new shares below $52 (shares currently trade around $60). I invite you to view all its recommendations (and its "buy-below" prices) free for 30 days. Click here to start. There's no obligation to subscribe.
This article was originally published Feb. 13, 2010. It has been updated.
Anand Chokkavelu owns shares of McDonald's. American Express, Costco Wholesale, and 3M are Motley Fool Inside Value picks. Costco Wholesale and Netflix are Motley Fool Stock Advisor recommendations. Johnson & Johnson is a Motley Fool Income Investor pick. Motley Fool Options has recommended a buy calls position on Johnson & Johnson. The Fool owns shares of Costco Wholesale and has a disclosure policy.
