To determine the best stocks for new money, you need to know two things:
- How great is the company?
- 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 Kraft
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 First Solar
|
Company |
What It Does |
Significant Potential Threats |
|---|---|---|
|
Kraft |
Food, including Kraft, Oreo, Oscar Meyer, and Nabisco products. |
There is no alternative to food, so just the normal competitive threats any company faces. |
|
UPS |
Shipping via its vast logistical network. |
Very dependent on the flow of goods through the economy, but replicating its network is costly. |
|
Disney |
Theme parks, movies, television (e.g., ABC and ESPN) |
Alternative entertainment sources like the Internet. |
|
First Solar |
Solar energy products. |
The viability of its products because of intense competition and innovation in a fast-changing industry. |
|
JPMorgan |
Bank. |
Regulation and the dangers of financial products that are difficult to evaluate from a risk standpoint. |
|
NVIDIA |
Graphics processing unit manufacturer. |
Intense competition as well as the threats from technological innovation. |
For the most part, the first three companies (Kraft, UPS, and Disney) 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 (First Solar, JPMorgan, and NVIDIA) 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 a company our analysts have identified as one of 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.
For the first step (identifying great companies), our market-beating Inside Value investing service has identified a handful of "Core Stocks" whose businesses they love. Payroll servicer Paychex
But 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 Inside Value analysts prefer the more time-intensive, but more thorough, method of using a discounted cash flow model.
After doing its due diligence and calculating Paychex's intrinsic value, the team recommended the company to its members last year. It currently trades under their "buy-below" price of $30 a share. I invite you to view all of their recommendations (and "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 Disney. Disney and Paychex are Motley Fool Inside Value selections. First Solar is a Motley Fool Rule Breakers recommendation. Disney and NVIDIA are Motley Fool Stock Advisor picks. Paychex and United Parcel Service are Motley Fool Income Investor choices. The Motley Fool has a disclosure policy.
