Which Large Cap Stock Passes the Triple Test?

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Large cap stocks could save you from a complete and utter disaster. As a general rule of thumb, I ensure three of the seven stocks in my portfolio are large caps, which helps provide some security if the market goes sour. Large cap failure is far less likely than the blow most small caps would endure during a recession.

Finding large caps that outperform the market takes bit of digging, but generally, I find it much easier than finding a small cap worthy of my portfolio. Three factors making up the triple test that I look at are the industry, profit margin, and chart. These components will improve the likelihood that the large caps you buy outperform the 11% compounded returns an index fund would likely accumulate.

Industry

With thousands of large caps from which to choose, it's important to determine the industry in which to invest. This will help narrow your options to a few hundred. Right now, I recommend investing in agriculture, which is experiencing increased demand as global food surpluses are consumed. With an ever-growing affluent global community, food demand will continue to increase. Mosaic (NYSE: MOS) stands out as an agriculture company with amazing potential. However, the business is suffering a setback with the low price of phosphate, though U.S. demand is increasing.

Revenue at Mosaic went from $3 billion in the second quarter of fiscal 2012 to $2.5 billion in the second quarter of fiscal 2013, which was reported in February. Mosaic also announced the company is adding 800,000 mt per year of ammonia capacity, which augments its current 500,000 mt at a plant in St. James Parish, Louisiana. The project costs an estimated $700 million.

Profit margin 

The next test requires investors to look into the company's books. As a rule of thumb, I look for a company with a profit margin of at least 10%. Anadarko Petroleum (NYSE: APC) last year realized a nearly 18% profit margin, which makes the company worthy of a close inspection. The independent exploration and production company owns the equivalent of about 2.5 billion barrels of oil. But in the year prior to the recent incredible returns, the company suffered a $3.4 billion loss, which shows instability and makes the company unworthy of a purchase, not to mention I consider the oil sector to be a risky play right now (stay tuned for more about that in an upcoming post).

Looking back at Mosaic, the company realized a 17% profit margin last year, and that margin had increased slightly in each of the previous three years. Sorry, Anadarko, but you're off the list. Mosaic, you can stay, but get ready for the final test.

Chart

In choosing the best large caps in which to invest, timing is vital. Unlike with small caps, I find the company's chart to be important at predicting future performance. During the depths of the 2008 and early 2009 recession, the sky was falling, and an overblown investor reaction to sell shares ensued. That left strong companies extremely undervalued, and many haven't returned to true valuation.

Looking at a company's chart, you can see the likely true value in the year leading up to the recession. If the stock still hasn't returned to that price, it could just be a matter of time. Take General Electric (NYSE: GE) as an example. The company's stock was in the low $40-range before the recession and then fell to under $10. Shares currently sit in the low to mid $20s. That represents a lot of potential upswing, but in taking a look at the second part of the triple test (profit margin), the company is bringing in roughly 10% consistently, which is significantly less than Mosaic.

So if Mosaic passes the "chart" test, then it looks like we have a winner. Prior to the recession, Mosaic was valued at nearly $150 per share before sinking to around $40. The stock is currently priced around $60, making this the champion of the triple test.

While Mosaic appears to have it all. The triple test is only designed to narrow down stock picks. Many other factors need to be taken into consideration before you can make an informed decision. For example, year-over-year revenue growth, money dedicated to research and development, and cash on hand all need to be examined before purchasing a stock.


Phillip Woolgar has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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