A Simple Lesson on Selecting Winning Stocks

I love a good teaching moment…

A few weeks ago, one of my researchers sent me two stock ideas. Both ideas had solid analyses and I liked them both.

But he left out one key piece of information that I needed to know before we committed to any stock.

Today, I’ll tell you what this crucial detail is. It’s a powerful way to pinpoint which stocks you want to own over the long term. And it’s easy to overlook…

My researcher’s pitch for both stocks was simple.

A while back, consumer-staple stocks were getting hammered.

They were down more than 10% since the start of 2018.

Regular readers will remember that I recently wrote about consumer staples being the most hated stocks in the market.

In that essay, I made the case that a few stocks in the sector were trading for bargain prices.

My researcher thought he found two of the most attractive stocks.

The first was spice maker McCormick (MKC). The second was condiment giant Kraft Heinz (KHC).

McCormick is the type of stock you would feel confident owning your entire life.

Think about it like this… When you go to the grocery store, what spices do you usually purchase? If you’re like most people, you buy McCormick spices. And you usually just do it instinctively – no marketing required.

No matter what is going on in the economy, folks are always going to purchase McCormick’s products.

And when you dig into McCormick as an investment, it’s a moneymaking machine. At the time of the stock pitch, McCormick’s gross margins were the highest they had been since 2010. The company’s free cash flow, which is the cash that’s left after a firm pays its bills and invests in capital improvements, has more than doubled since 2010. Also, McCormick has increased its annual dividend payment every year for 31 consecutive years.

All things I love to see.

With all the negativity toward consumer staples in general, McCormick’s stock was trading for less than what we thought it was worth.

Kraft Heinz was a similar story. It is the brand for ketchup. Its Heinz mustard is one of the top mustards on the market, and the company also sells a variety of other popular condiments and snacks.

This company enjoys a lot of brand loyalty. If folks have been buying Kraft ketchup and Heinz mustard for years, they are unlikely to ever switch to another brand.

At the time, Kraft Heinz’s stock was dirt-cheap… Its price-to-earnings ratio was near a multiyear low. Kraft Heinz was only trading for 16 times earnings, nearly half of its three-year average of about 29 times earnings.

Both stocks sound pretty enticing, right?

I thought so… But I needed to know one more thing before I made a decision.

My response to my researcher was short. It was a teaching moment (and I can never turn down a teaching moment).

All I said was: “I like both. But I ask… What is the top line doing?”

When I mentioned the top line, I was talking about the company’s overall revenue. I wanted to know if both companies were growing their sales every year.

You see, McCormick is the poster child for top-line revenue growth. It has grown its revenues 28 out of the past 30 years, a stretch that included three recessions.

Kraft Heinz, on the other hand, has not. Over the past three years, revenue has pretty much gone nowhere. It was $26.5 billion in 2016 and $26.2 billion in 2017. Over the past 12 months, the company made $26.2 billion.

The lesson here is simple. Why would you want to own a portion of a company that has a hard time growing its sales each year… especially in today’s economy – where consumer spending is robust, gross domestic product is projected to grow 3% this year, and the unemployment rate is less than 4%?

If a firm can’t grow in this environment, chances are it won’t do well when the economy is in a recession.

Sometimes investors can get caught up in financial metrics such as valuation ratios, leverage ratios, operating margins, profit margins… the list goes on and on.

Those metrics are useful, but sometimes it’s best not to overthink things.

Remember, when you buy a stock, you’re buying an ownership stake in a company. Think about the products and services it sells. And in general, stay away from companies that struggle to grow their revenues each year.

Here’s to our health, wealth, and a great retirement,

Dr. David Eifrig

Source: Daily Wealth