Stock Picking Basics (1)

October 1, 2007

With the advent of “systems” for investing and a new wealth of information about companies, it can be hard to figure out which stocks you want to invest in. While many commentators will tell you about a lot of different companies from a variety of industries, sometimes it helps to just simplify. One of the most basic stock picking adages is to buy what you know. There is also the corollary to buy what you buy. Now how do you put these sayings into practice.

If you are just starting out in the world of investing and have your strategy and comfort with risk evaluated, the next step is to start looking into companies you wish to invest in. Before looking for exotic companies with high returns, you really don’t even have to go to far to find successful companies that have had great returns already. For the poor college student/new college graduate that’s too lazy to cook, there are plenty of fast food restaurants that have been returning greater than 10% over the past few years. Companies like McDonalds (MCD), Wendy’s (WEN), Jack in the Box (JBX), and YUM Brands (YUM) which owns KFC, Taco Bell, and Pizza Hut are all strong companies with a lot of growth potential in the near term. When you go to these places for lunch or dinner then you’ll just be putting your money back into your investments. Plus, if you goes to these restaurants and watch how brisk business is at times, then you already have a bellweather into the health of the company’s performance. If you find you’re the only one in there, then perhaps it’s time to pull out of fast food restaurants.

Not one to partake in fast food, how about consumer electronics? Still seeing lots of iPods or hearing about all the new TV’s people are buying? Companies like Apple (AAPL), Research in Motion (RIMM) the maker of the Blackberry, Sony (SNE), or Philips Electronics (PHG) are all good places to start if you also plan on upgrading a few of your electronic toys in the near future.

So what are you spending your money on every week? Why not invest in the companies that are going to be getting your money anyways. The gas companies are not a bad idea if you have a favorite gas station to fill up your car. Ask yourself some of these questions when brainstorming about which companies to invest your money. Where are you getting your food from or what kind of drinks are your favorite? What about the clothes you buy or even the bathroom products you use? This is why the adage of investing in what you know and what you buy is such an easily understood idea that can be oft overlooked. Plus, you get the advantage of seeing how the company is actually performing without having to wait for its financial reports every quarter.

As of this writing, I currently own shares of YUM Brands (YUM).


Forget Share Price, Percentage Gain is All That Matters

September 3, 2007

Some investors are very hesitant when it comes to buying cheap stocks under $10, and some investors are hesitant when it comes to buying expensive stocks that are over $100. Investors need to get out of the mindset of how much a stock cost, but instead think about the percentage gain they can make from a company or the future outlook of a particular company, regardless of its price. If you buy a $10 stock, selling at $11 is a 10% gain. If you buy a $100 stock, selling at $110 produces a 10% gain. It doesn’t matter how many shares you can buy of a company, but only the percentage gain you can attain from purchasing any given amount of shares of a company. Producing a 25% gain for your entire portfolio during any given year would be wonderful, and it shouldn’t matter how much you paid per share.

Consider the two following stock purchasing scenarios with an original investment of $2000:

1) Buy 4 shares of Google (GOOG) at $500 and attain a 20% gain by selling at $600
2) Buy 100 shares of Aeropostale (ARO) at $20 and attain a 20% gain by selling at $24

Regardless of the two scenarios just mentioned, a 20% gain and a $400 gain has been achieved. Doesn’t matter if you have an odd lot amount of shares or an even 100 shares or how much the original share price is. The 20% gain is all that matters.

Stocks with a market capitalization (outstanding shares times stock share price) under a billion dollars are considered small cap companies that usually have the best possibility to be growth stocks. Companies with over 10 billion dollars in market cap are labeled as large cap companies, and much of their primary growth phase has generally passed. It is more difficult to sustain such a large level of growth when the company is already so big. On the other hand, some examples of large cap companies in recent years that have shown much growth despite their worldwide presence are companies like McDonalds (increased 65% since the middle of 2005) or Chevron (increased 45% since the middle of 2006). McDonalds (MCD) and Chevron (CVX) represent markets caps of 58 and 157 billion respectively with dividends above 2%.

Even though I stated that small cap companies have the opportunities for the largest amount of growth, they are also more susceptible to volatility if they don’t grow as fast as investors anticipate. They will generally fall faster than large cap companies in bear markets because they won’t have as much cash flow as large companies and will probably have a higher debt-to-equity ratio. When earnings come out for these high-growth small cap companies, investors will look for earning to exceed expectations. Even just meeting expectations may not be good enough to propel the stock higher.


Starbucks: Add a Caffeine Shot to Your Portfolio

July 18, 2007

After hitting a high of $40/share in early October, Starbucks (SBUX) has fallen to a current value of $25.87, down 35% and is at a 22-month low. Why is this stock down so much?

1) In late June, the CFO of Starbucks was quoted that the high end of 2007 earnings forecast ($.87-$.89/share) “will be very challenging” to attain due to:
a) rising price of milk (which is directly related to the increase in ethanol production)
b) slowing sales growth in US Starbucks locations

2) Increased competition from other competitors getting into the coffee business such as McDonalds (MCD) who has a premium coffee that has received positive reviews.

Reasons for optimism:

a) Starbucks says that China will be the biggest market outside of the US and will increase international stores by 20% over the next few years. Key growth will be outside of the US in markets that Starbucks has yet to establish. Locations in Russia and India are poised to open later this year. Americans already knows what to expect out of Starbucks when you go to the one of 6,281 Starbucks locations. The goal is to get a foothold in Chinese, Japanese, and Brazilian markets as soon as possible.

b) Adding more drive through locations is a no-brainer. As of October 2006, Starbucks operated 1,600 drive through locations. Life is so fast-paced here in America that sometimes people just want to pay for their $4 latte and get on with the rest of their work day. Some people don’t want to deal with the long lines inside the store and hassle of carrying coffee to their car. If America wants coffee on the go, then that’s what she’ll get.

c) Peet’s Coffee (PEET) isn’t considered direct competition for Starbucks, but Dunkin’ Donuts is probably the closes competitor. These two chains target entirely different demographics. Dunkin’ Donuts was originally founded in 1950 in the Northeast (Quincy, Massachusetts) and appeals more to the lower/middle-class America that is looking to get a cheap coffee and a more down-to-earth experience. Dunkin’ Donuts operates 6,000 shops worldwide compared to Starbucks 14,000.

d) Modification of their food menu because sometimes people don’t want just coffee. Customers sometimes need some sustenance to go with their coffee and Starbucks has delivered recently. Additions to their lunch menu with new items including a tomato mozzarella salad, fiesta salad with grilled chicken, roasted corn and black beans, bowtie pasta with goat cheese, and Asian sesame noodle salad. To cater toward the health conscious consumer, McDonalds did an overhaul of their menu over the last few years including salads, premium chicken sandwiches, negating the supersize option, and offering other healthier options. McDonalds stock price has doubled over the last three years and their upward momentum appears to be continuing. Starbucks understands that they are not just a coffeehouse anymore.

Benefit or downfall?
Starbucks has over 14,000 stores open around the world and aims to have over 40,000 stores in existence for the long term (with over half outside of the US). But some say that with so many stores open this will dilute the appeal of a Starbucks coffee and saturate its image.

The way I see it, if Starbucks can open stores across the street from each other, then they can handle losing the “novelty” label. They cater toward a crowd that is looking for a pleasant ambiance and a casual place to have a drink with a friend, conduct an interview, work on your laptop during lunch, or just have a place to cool off during summer.

Starbucks is at a discounted price and I believe will have more upside potential with minimal risk. Target price: $33