Consistent with the approach taken over the past five years, we'll use the techniques of value investing described elsewhere on this website to identify five good stocks to buy in 2016. Last year was a rough one for investors, with broader measures of the market's performance remaining relatively flat.
The Dow Jones Industrial Average was down 2.29%, while the S&P 500 Index finished with a 0.69% loss in 2015. The last time the DJIA surpassed a major milestone was back in July of 2014, when it passed through the 17,000 mark for the first time.
We're going to start with a brief discussion of the stock picks' performance from last year. Next, we'll briefly run through the process of finding stocks that represent a good value. Then we'll finish up with a list of stocks for 2016, including the rationale for choosing each of the stocks picked.
Three of the five stocks picked last year performed well when compared to both the S&P 500 and the Dow as demonstrated in the table below. The exceptions being International Business Machines (IBM), and Western Digital which performed poorly last year:
|JPM||JPMorgan Chase & Co.||5.66%|
|WFC||Wells Fargo & Co.||-0.62%|
|IGSPC||S&P 500 Index||-0.69%|
|IBM||International Business Machines Corp.||-15.08%|
|WDC||Western Digital Corp.||-45.62%|
The average of the portfolio was -9.97%. This performance is extremely poor when compared to our picks in 2014, which more than doubled the performance of the DJIA. The standouts include IBM (which also performed poorly in 2014) and Western Digital, which is struggling as solid state storage erodes its platter-based hard drive offerings. The performance of this approach over the last five years versus the S&P 500 and DJIA appears in the following table:
|Prior Year Stock Picks||15.2%||10.6%||59.0%||20.0%||-9.97|
The process used for picking stocks is based on a systematic approach to researching and selecting stocks. This multi-step approach is based on value investing; something embraced by Benjamin Graham, an economist and premier investor.
There is always a choice to invest money in relatively safe, risk-free securities such as government bonds. When buying stock in a company, it's important to be adequately compensated for the additional risk; that means investing in companies with high intrinsic value.
When choosing stocks, the following formula was used to initially screen companies. The intrinsic value was calculated, and then compared with the last price of the stock. Companies were ranked according to their intrinsic value to last price ratio, where intrinsic value was calculated as:
Intrinsic Value = (EPS x (8.5 + 2G) x 4.4) / Y
In the above example, the value of Y was based on the 20-year composite AAA yield of 2.25%
Another important measure of a company's financial strength is their earnings per share. This measure tells the investor 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. This projection is based on guidance received from the company they're analyzing. The future earnings of a company are the key to deriving an estimate of a stock's future price.
The last screen involves choosing excellent stocks. This eliminates from consideration companies that sell commodity-type products. It's important to find companies that command a price premium in the marketplace because they have either strong brand recognition and / or loyal customers.
The above stock screening resulted in roughly 220 candidate companies from a universe of around 2,000 stocks. The five good stocks to buy in 2016 were selected because of their strong financial performance and widespread brand recognition.
|Ticker||Company||Industry / Sector|
|AAPL||Apple Inc.||Consumer Goods / Electronic Equipment|
|JPM||JPMorgan Chase & Co.||Financial / Money Center Banks|
|GOOG||Alphabet Inc.||Technology / Internet Information Providers|
|HON||Honeywell International||Industrial Goods / Diversified Machinery|
|MMM||3M Corporation||Industrial Goods / Diversified Machinery|
All of the above stocks satisfied the requirements of the process, and show strength in the following three areas:
Below is a brief description of the companies picked in 2016, and their major business operations:
There are many ways to go about picking stocks, and we've mentioned several other methods in articles 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 2016. It serves as a demonstration of the thought process behind a sound stock-picking technique.
About the Author - Five Good Stocks to Buy in 2016 - Copyright © 2016 Money-Zine.com