Large caps make it happen
On to Plan B. Who else has made money in investing — using a style you can apply yourself?
Through his hands-on ownership and insightful purchases of stocks — many of them well-branded large caps like Coca-Cola (NYSE: KO ) — Warren Buffett became the greatest
investor of all time. We’re talking 24% annual returns during a period when the large-cap benchmark, the S&P 500, has scored something like 10%. Hands-on ownership isn’t in the cards for most of us, but finding great large caps is something we can all take a stab at.
And Bill Miller, the older-guy-next-door-looking guru from Baltimore who runs the Legg Mason Value Trust, draws a captive audience every year when his returns are announced. Why? To see if he’s beaten the large-cap benchmark another year in a row. His tally so far? Fifteen years running, and average annual returns north of 16%.
Like Warren, Bill shows his hand regularly. And like Warren, Bill sports plenty of well-chosen large-cap stocks. So do many other top fund managers.
Beaten down and ready for a comeback
Don’t they have to own large caps, given all the money they manage? Yes. But I’m not sure the best money managers would want to be in small caps these days.
Sure, I’ve been, and still am, a small-cap guy. They’ve been on a tear for quite a while, especially for the past several years. Commodities, too, are at all-time highs. And foreign stocks, particularly those of emerging markets, have been rocketing to new heights.
Everything except large caps have been rolling, it seems. Their stock prices have watched from the sidelines as corporate earnings have roared on by. BusinessWeek notes that first-quarter 2006 earnings per share are up a whopping 14% for the S&P 500. And the index itself — the stock prices, in other words — are up less than 3% … and screaming “buy me!” to many an investing ear.
Aren’t earnings just catching up with valuations? That’s possible, but our potentially dour economic climate — and the flight to quality that could ensue — gives us one more reason to consider blue chips.
Now is the time for blue chips
In fact, that’s my pitch to you. Now is the time for blue chips. But not just any blue chips. You want ones that will more than rise with the tide, with the inner staying power to hold their ground should the going get tough.
To find those special blue chips with “inner staying power,” here are 10 pieces of old-fashioned kitchen-table wisdom that should help enhance your equity returns:
Find strong — but not majority — management ownership.
Look for management that’s been with the business a long time.
Seek businesses with dominating, unapproachable brands.
Find companies whose returns on capital exceed their costs of capital.
Hunt for stocks with prominent negative catalysts that the market may be focusing excessively on.
Favor companies with the potential to go global — it leaves more room for growth.
Identify businesses pursuing less-contested markets or niches.
Find companies unafraid to return money to shareholders — it says a lot about the character of management.
Don’t automatically shy away from new management that has proved itself in related situations — management change can be a great turnaround catalyst.
Buy companies whose businesses and industries you know really, really well.
We put these into practice last year in 10 Monster Stocks for the Next Decade, our inaugural blue-chip report, and it worked out OK. In a year when the S&P 500 managed 9%, our report threw down a market-whooping 23% overall return.
But nobody bats a thousand in investing, particularly over the short term, even when loyally abiding by those 10 pieces of wisdom. So here are the three blue chips from the report that struggled the most:
Microsoft (Nasdaq: MSFT )
Johnson & Johnson (NYSE: JNJ )
Church & Dwight (NYSE: CHD )
Disappointing though those returns may be, they might have been much worse had the stocks not been blue chips. Big boats can be hard to sink, and that’s the reason why steady, large businesses make such a great foundation for any portfolio.
Yet the size and steadiness of blue-chip stocks absolutely does not preclude them from earning market-beating returns: In fact, we had a few picks last year that have absolutely pummeled the market:
Nokia (NYSE: NOK )
Barclays (NYSE: BCS )
The Foolish bottom line
A few carefully chosen blue-chip stocks can make a great foundation for a successful long-term portfolio by offering solid returns with a little bit less downside volatility. And that can be a pretty good deal in a crazy market like this one.
You can get started finding those companies by starting with the 10 tips I gave you above, or you can pick up a copy of our brand-new blue chip report, 10 Monster Stocks to Anchor Your Portfolio.
Will we return another 23%? Of course, nothing is guaranteed in investing. Stocks go up as well as down. But blue chips are back. And whether it’s on your own, with our advice, or with our report, I encourage you to give them a look.
Ready to rock in the world of blue chips? Click right here to check out The Motley Fool’s 2006 blue-chip report, 10 Monster Stocks to Anchor Your Portfolio . On top of the full report — 10 blue-chip recommendations, plus two bonus picks and a blue-chip fund — you’ll get The 7 “Blue Chips” That Could Sink You, a special report on seven large caps our analysts feel may underwhelm … possibly in a big way. Are any of these sinkers in your portfolio?
James Early owns no shares mentioned in this article. Microsoft and Coca-Cola are Motley Fool Inside Value recommendations. Johnson & Johnson is a Motley Fool Income Investor pick. The Motley Fool has a disclosure policy.