Five Good Stocks to Buy in 2010

After a relatively good year in the stock market, investors are anxious to see what 2010 will bring.  We're going to continue down the path of value investing, and will use the techniques described elsewhere in this publication to find five good stocks to buy in 2010.

Buying Stocks in a Volatile Market

The Dow Jones Industrial Average was up 18.8%, while the S&P 500 finished the year up 23.4%.  For much of 2009, the stock market had investors guessing.  The first three months of the year continued the downward trend that started in December 2007.  But a rally that began in early March seemed to set the tone for the remainder of 2009.

But as the saying goes, past performance is not necessarily indicative of future results.  With the broader measures of the market up nearly 25% on the year, many investors may look at 2010 as an opportunity to move back into the market from the sidelines.

Picking Stocks

As we did in prior years, we're first going to discuss the performance of the picks from last year - Five Good Stocks to Buy in 2009.  Next, we'll briefly run through the process of finding stocks that represent a good value.  Finally, we'll provide a list of stocks for 2010, including the rationale for choosing each of the stocks that were picked.

2009 Stock Picks

In 2009, the S&P 500 Index was up nearly 25% for the year, while the Dow Jones Industrial Average was up nearly 20%.  Overall, two out of the five stocks picked last year outperformed the S&P 500, while three stocks outperformed the Dow as demonstrated in the table below:

The average of the portfolio was 31.8%, over 8% higher than the S&P 500 performance and 13% higher than the DJIA.  Schlumberger Limited benefited from growing interest in extracting natural gas from shale.  Surprisingly, the two companies picked in the retail industry wound up at opposite ends of the performance spectrum.  TJX was the top performer, while Wal-Mart performed poorly.

Good Stocks to Buy

What do we mean when we're talking about a good stock to buy?  We're talking about a systematic approach to researching and selecting stocks.  This 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, then 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.  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 less conservative approach to the stocks selected as a good choice to buy this year.  The list is going to contain two stocks that benefit from an increase in defense spending.  The list also contains three stocks that rely heavily on energy prices.

With that introduction, it's time to share a list of five good stocks to pick in 2010:

Five Good Stocks to Buy in 2010

Rationale for 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 manufacture their products less expensively.
• Return on Equity - All of the stocks picked have demonstrated strong growth in return on equity over the last five years.
• 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 demonstrated they have a strong balance sheet when looking at interest coverage and debt to equity ratios.

Stocks Picked in 2010

In case you're not familiar with some of the stocks picked in 2010, here is a brief description of the company and its business operations:

• Suburban Propane Partners, LP - engages in the distribution of propane, fuel oil, kerosene, diesel fuel, gasoline, and refined fuels.  Suburban Propane also engages in the marketing of natural gas and electricity in deregulated markets.
• Chevron Corporation - operates as an integrated energy company worldwide.  Petroleum operations include the exploration, development, production, and marketing of crude oil and natural gas.
• Lockheed Martin Corporation - engages in the research, design, development, manufacture, integration, and sustainment of advanced technology systems, products, and services in the United States as well as internationally.
• Exelon Corporation - through its subsidiaries, engages in the generation, transmission, distribution, and sale of electricity to residential, commercial, industrial, and wholesale customers in northern Illinois.  Exelon also purchases and sells electricity and natural gas on a retail basis to customers in southeastern Pennsylvania.
• General Dynamics Corporation - provides business aviation; combat vehicles, weapons systems, and munitions; shipbuilding design and construction; and information systems, technologies, and services.

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 2010.  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 2010

Copyright © 2010 - 2011 Money-Zine.com