Where to Put Your Money in a Bull Market
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The incredible bull market fed by Ben Bernanke's monetary stimulus has inflated the prices of many stocks well beyond their intrinsic value. Although few bargains remain, many investors cannot bring themselves to move to a full cash position; the market could continue its upward climb for another year or more, causing investors who stay on the sidelines to miss out.
The solution is not to buy the high-flying growth stocks that have been shooting skywards since late 2012. Instead, investors should allocate available cash toward great businesses selling at reasonable prices.
Great businesses will continue to generate substantial cash flow even if the economy turns down again, whereas growth at companies like Chipotle could easily stall out if the economy falls into another recession.
At the same time, investors who pay enormous multiples for great businesses will be sorry they did so; if you pay $30 for a company that reliably produces $1, you are set to lose a lot of money when the market crashes. However, paying $15 for $1 of reliable earnings is a great deal in this market. This is the kind of situation investors should be buying into today.
Three great businesses for reasonable prices
There are no amazing bargains in the great business arena today, but concentrating your portfolio on a few reasonably-priced businesses will lead to market-beating returns over the next couple of years.
Coca-Cola (NYSE: KO) is one company that sells at a reasonable price. As the leading carbonated soft drink company, Coca-Cola's brand is ubiquitous throughout the world. Its enormous distribution network cannot be replicated by any but the largest of competitors. As a result, the company's cash flows are ample and growing.
Coca-Cola generated $1.73 per share in free cash flow over the last four quarters. At a recent price just below $41 per share, the stock trades at a 4.3% yield to trailing free cash flow. This does not sound impressive until you consider that the company has grown free cash flow per share at a 7% compound annual rate over the last decade.
What's more, the company has increased share repurchases over the last few years. It now spends over $3 billion per year repurchasing stock. This will enable free cash flow per share to grow at a higher rate than cash flows over the next decade. When share repurchases and revenue growth are combined with the company's $4.5 billion per year dividend, shareholder return may exceed 10%.
Warren Buffett's Berkshire Hathaway (NYSE: BRK-B) is another great business selling at a reasonable price. An investor could make Berkshire a 100% position and still claim to be diversified; the company is a roll-up of some of America's greatest companies, and it is quickly adding great businesses from other parts of the world as well. Buffett's focus on buying businesses with staying power should enable the company to generate massive earnings for decades into the future.
Berkshire has traditionally generated an 8% to 10% return on equity. It currently trades at 1.4 times book value, which is about 15 times normal earnings based on historical return on equity. However, the company has compounded book value at nearly 20% per year since Buffett took over as CEO, so investors who buy now will likely end up with a market-beating return.
Finally, third-party logistics provider CH Robinson Worldwide (NASDAQ: CHRW) is the last great business trading at a low price that we will highlight. Like Coca-Cola's distribution network, CH Robinson's enormous network of carriers and shippers is impossible to replicate. The company's scale allows it to provide customers with the widest selection of routes and methods of transportation, while also giving it the ability to hire top talent in logistics consulting. As a result, the company's value proposition is second-to-none in the industry.
As a result of its wide moat, CH Robinson earns relatively stable margins -- though the industry is subject to some cyclicality. The stock trades at 16.6 times trailing earnings, so investors can expect a 5% to 6% annual return over a long holding period. Although this is not as great as the return one can get from Berkshire or Coca-Cola, it is a good return for a great business in an overheated market.
The current bull market will make you look smart regardless of what you buy, but the eventual correction will make geniuses out of investors who focus on buying great businesses at reasonable prices.
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola. 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!