Five Good Stocks to Buy in 2008

There is no doubt in anyone's mind that the stock market is off to a rough start in 2008.  But even in a down market, it's always possible to find stocks offering a great value to investors.   Here we're going to walk you through an approach to finding five good stocks to buy in 2008.

Buying Stocks in a Bear Market

In January (at the time of this writing), the S&P 500 Index was down over 9%, the Dow Jones Industrial Average was down over 8%.  Investors have also seen a lot of negative news lately including:

• Large losses at financial institutions such as Merrill Lynch (MER) and Citigroup (C) following the lending debacle of 2007.
• A steady stream of unattractive economic data such as a slow-down in the U.S. factory sector.

But as investors, we can never be sure what tomorrow's stock market will bring.  Even a bear market provides an opportunity to buy stocks at bargain prices.  With that in mind, let's start talking about a list of good stocks to buy in 2008.

Picking Stocks

In this article we're first going to discuss the picks from last year, appearing in our article Ten Good Stocks to Buy in 2007.  Next, we'll briefly run through an approach to finding stocks that represent a good value.  Finally, we'll provide a list of stocks including the rationale for choosing each of the stocks that were picked.

2007 Stock Picks

In 2007, the S&P 500 Index was up only 3.5% for the year.  Unfortunately, the stock picks last year didn't outperform the S&P 500, and the overall portfolio was pretty much flat on the year.  We did pick some notable winners including Tupperware Brands (+ 46.7%), Becton Dickinson, Co. (+ 18.5%), Colgate Palmolive (+ 18.2%), and 3M Company (+ 8.8%).

But the portfolio also fell victim to the housing decline, as the home furnishings and electronics giant Craftmade International, Inc (- 53.7%) registered a big loss on the year.  Another company we selected in 2007, Harman International (- 27.5%), was to be acquired by KKR and GS Capital Partners.  The price of Harman International rose over 10% prior to the announcement in April, only to quickly drop in late September when the acquisition failed.

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.  This five step approach, which is based on value investing, includes evaluating each stock for the following:

Excellent Stocks

The first filter to apply when selecting stocks to buy is to choose excellent stocks.  By this we don't want to look for companies that are selling commodity-type products.  We want to find companies that can command a premium price 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 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 price in the future.

Five Good Stocks to Buy

We're taking a somewhat conservative approach to the stocks we're saying are good to buy this year.  This list contains several stocks investors would consider noncyclical stocks - meaning their performance should be steadier in turbulent times.  One example of a noncyclical stock would be a company that sells nondurable, or consumable, goods such as Colgate Palmolive.

With that introduction, it's time to share a list of five good stocks to pick in 2008:

Five Good Stocks to Buy in 2008

Rationale for the Stock Picks

All of the above stocks satisfied the requirements mentioned earlier 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 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 Picked in 2008

Just in case you're not familiar with some of the stocks picked in 2008, here is a brief description of the company and its business operations:

• Emerson Electric - a diversified global technology company, engaging in designing and supplying product technology and delivering engineering services to industrial, commercial and consumer markets worldwide.
• Colgate Palmolive - markets its oral, personal, household surface, fabric care, and pet nutrition products in over 200 countries.  Colgate Palmolive also appeared on the stock pick list last year.
• Tupperware Brands Corporation - makes and markets consumer products for the home, principally food storage containers.  Tupperware is the second company to appear in this year's list that also appeared in the list last year.
• Kellogg Co. - the parent company along with its subsidiaries engage in the manufacture and marketing of ready-to-eat cereal and convenience foods worldwide.
• Darden Restaurants Inc. - engages in the ownership and operation of casual dining restaurants in the United States and Canada. The company operates restaurants under the names Red Lobster, Olive Garden, Bahama Breeze, Smokey Bones, and Seasons 52.

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 beyond distributing a list of stocks to buy in 2008.  Its primary purpose is to demonstrate the thought process behind sound stock-picking techniques.

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