Consistent with the approach taken over the past seven years, we'll use the techniques of value investing described elsewhere on this website to identify five good stocks to buy in 2018. Last year was a very good one for investors in the stock market, with broader measures of the market's performance rising significantly.
The Dow Jones Industrial Average was up 25.1%, while the S&P 500 Index finished the year with a 18.9% gain. The DJIA also hit several new milestones, surpassing the 24,000 mark for the first time on November 30, 2017.
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 2018, including the rationale for choosing each of the stocks selected.
Three of the five stocks picked last year performed well when compared to the Dow and four of five stocks beat the S&P 500. As the table below demonstrates, the worst performing stock was Walt Disney Co., which performed poorly relative to its peers:
|INX||S&P 500 Index||18.9%|
|DIS||Walt Disney Co.||1.6%|
The average of the portfolio was 27.7%. This performance is much better than our 2016 picks, and is slightly ahead of the DJIA while beating the S&P 500 by a sizable margin. The standouts include Apple Inc., Alphabet Inc., and 3M Corporation.
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||59.0%||20.0%||-9.97||14.57%||27.7%|
The process used for picking securities 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 adequately compensate for the additional risk; that means investing in companies with high intrinsic value.
is first calculated, and then compared with the last price of the stock. Ranking companies is then possible according to their intrinsic value and last price ratio, using the intrinsic value calculation is shown below:
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 each 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 240 candidate companies from a universe of around 2,000 stocks. The five good stocks to buy in 2018 were selected because of their strong financial performance and widespread brand recognition.
|Ticker||Company||Industry / Sector|
|MMM||3M Co.||Industrial Goods / Diversified Machinery|
|HON||Honeywell International||Industrial Goods / Diversified Machinery|
|JPM||JPMorgan Chase & Co.||Financial / Money Center Banks|
|C||Citigroup Inc||Financial / Money Center Banks|
|DIS||Walt Disney Co.||Services / Entertainment - Diversified|
All 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 2018, 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 2018. It serves as a demonstration of the thought process behind a sound stock-picking technique.
About the Author - Five Good Stocks to Buy in 2018