Five Good Stocks to Buy in 2009

After another tough year in the stock market, investors are anxious to see what 2009 has in the offing.  We're going to continue down our path of value investing and use the techniques described in this publication to find five good stocks to buy in 2009.

Buying Stocks in a Volatile Market

For the year, the Dow Jones Industrial Average was down 33.5%, while the S&P 500 finished the year down 38.5%.  And while during much of the year stocks seemed like they were going to break out of the bear market, the stock market crash of 2008 in October set the tone for the remainder of year including:

• Credit Market Collapse - the sub-prime mortgage market disintegrates as the practice of lending to individuals with poor credit finally catches up with the industry.
• Financial Instability Grows - Bear Stearns, Fannie Mae, Freddie Mac, AIG, Merrill Lynch, and Lehman Brothers all fall victim to poor lending practices as  each of these institutions struggles to remain solvent.

But as the saying goes, past performance is not necessarily indicative of future results.  And with the broader measures of the market down nearly 40% on the year, many investors may look at 2009 as an opportunity to buy stocks at bargain prices.

Picking Stocks

As we did last time, we're first going to discuss the performance of our picks from last year - Five Good Stocks to Buy in 2008.  Next, we'll briefly run through the process of finding stocks that represent a good value.  Finally, we'll provide our list of stocks for 2009 including our rationale for choosing each of the stocks we've picked.

Our 2008 Stock Picks

In 2008, the S&P 500 Index was down nearly 40% for the year, while the Dow Jones Industrial Average was down nearly 35%.  Overall, four out of the five stocks we picked last year outperformed both of these broader measures of market performance as demonstrated in the table below:

One of the reasons our stock picks may have performed well could be attributed to the fact that several of those stocks are in what might be considered non-cyclical industries - such as food, utilities, and non-durable goods.  During market downturns, defensive stocks such as Kellogg Co. and Colgate Palmolive tend to out-perform the market.

Good Stocks to Buy

What do we mean when we're talking about a good stock to buy?  Here we're talking about a systematic approach to researching and selecting stocks.  Our five step approach, which is based on value investing, includes evaluating each stock for the following:

Excellent Stocks

The first filter we apply when selecting stocks to buy is to choose excellent stocks.  We don't want to look for companies that are selling commodity-type products.  We want to find companies that can command a price premium in the marketplace because they have either strong brand recognition and / or loyal customers.

Intrinsic Value

We always have a choice of investing our money in relatively safe, risk-free, securities such as government bonds.  But if we're going to be buying stock in a company, we want to be sure that we're being adequately compensated for the additional risk.  That means we're going to want to invest in companies with high intrinsic value.

Return on Equity

A stock's return on equity is defined as the total return to shareholders divided by stockholder's equity.  In practice, it is calculated by taking a company's net income and dividing it by stockholder's equity.  Return on equity is arguably one of the most important measures of a company's profitability.  And there should be a strong relationship between a stock's market price, its actual return in the past, and its expected profitability in the future.

Earnings per Share

Another very important measure of a company's financial strength is earnings per share.  This measure tells us how much money a company earned in a given time period, stated in terms of each share of common stock issued.  Industry analysts often project earnings per share into the future - based on guidance they receive from the company they're analyzing.  This projected earnings value is key to deriving an estimate of a stock's future price.

Five Good Stocks to Buy

We're taking a somewhat conservative approach to the stocks we're saying are good to buy this year.  Once again, our list is going to contain several defensive stocks - so our hope is their performance will be steady in 2009.  If the stock market enters a bull market, there is a good chance our stock picks will under-perform the market.

And with that introduction, it's time to share our list of five good stocks to pick in 2009:

Five Good Stocks to Buy in 2009

Rationale for Our Stock Picks

All of the above stocks satisfied our requirements because they all have demonstrated they can outperform their industry.  They also show strength in the following four areas:

• Net Profit Margins - Net profit margins for these companies are all above their industry average.  This is a good indication that they're able to sell their products at a premium price, or they can manufacturer their products less expensively.
• Return on Equity - All of the stocks we've picked have a five-year return on equity that is above their industry average.
• Earnings Per Share - The consensus among market analysts is that these companies are all expected to demonstrate strong earnings per share growth over the next five years.
• Financial Stability - Finally, all of these companies demonstrate they have a strong balance sheet when looking at interest coverage and debt to equity ratios.

Stocks We Picked in 2009

Just in case you're not familiar with some of the stocks we picked in 2009, here is a brief description of the company and its business operations:

• Nationwide Health REIT - a real estate investment trust (REIT) that invests primarily in healthcare-related senior housing, long-term care properties and medical office buildings.
• Schlumberger Limited - an oilfield service company supplying a range of technology services and solutions to the international petroleum industry.
• Baxter International Inc. - a global diversified healthcare company that applies a combination of expertise in medical devices, pharmaceuticals and biotechnology to create products that advance patient care worldwide.
• TJX Companies Inc. - an off-price retailer of apparel and home fashions in the United States and worldwide.  The company operates T.J. Maxx, Marshalls and A.J. Wright chains in the United States, the Winners chain in Canada, and the T.K. Maxx chain in Europe.
• Wal-Mart Stores Inc. - earns the trust of its customers every day by providing an assortment of merchandise and services at every day low prices (EDLP), while fostering a culture that rewards and embraces mutual respect, integrity, and diversity.  Wal-Mart's operations comprise three business segments: Wal-Mart Stores, Sam's Club and International.

Stock Pick Disclaimer

There are many ways to go about picking stocks and we've mentioned several other methods in publications such as Dogs of the Dow and Dow Diamonds.  The purpose of this publication goes well beyond distributing a list of stocks to buy in 2009.  More importantly, it serves as a demonstration of the thought process behind a sound stock-picking technique.

About the Author - Five Good Stocks to Buy in 2009

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