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Tuesday, August 23, 2011
In my DailyWealth essay last week, I gave you two simple tests you can use to see if a company is safe enough to invest in.
After all, your success as an investor in the coming years comes down to realizing investment is about buying high-quality businesses... not buying chips in the Wall Street casino. There's too much risk in the world to invest like folks did in the 1990s... when everything went up.
The first safety test is to look at a company's stock price performance in 2008. The stock market crashed in 2008. So if your stock held its value or even rose, you know it's a safe investment. If your stock tanked with the rest of the stock market, it's not safe. It could be a hot potato that traders toss back and forth between each other.
Second, you want to look at a company's debt load. Debt is like lighter fluid. Use it right and your food's ready sooner. Use it wrong and you lose your eyebrows. If safety is your highest goal, you should avoid companies with debt.
Today, I'm adding a third quality to look for in a safe company you can own for many years: profit strength.
The only reason you buy stock in a company is to stake your claim to that company's future profit stream... and direct a portion of that profit stream into your account via dividends. That's it. Pick any other reason to buy a stock and you're just gambling. So when you buy the stock, you need to know its profits won't suddenly dry up. If they do, your investment's going to evaporate with them.
So how do you identify companies with profit strength? You're looking for businesses that are protected from two major risks – economic risk and business-related risk.
Let's look at economic risk first. This is the risk that the entire economy contracts. This is a recession. Consumers stop buying. Businesses stop investing.
For example, consider a company that makes luxury goods like Louis Vuitton. When the economy contracts, are people likely to buy more or fewer $5,000 handbags? Louis Vuitton takes large economic risks. It's not a super-safe investment.
Compare this to an industry like insurance. Do people stop dying in a recession? Do they stop driving their cars? Do they stop having house fires? Do hurricanes stop occurring? Of course not. People always need insurance, recession or not.
Insurance companies are one of my favorite recession-proof businesses. I especially like life insurance. Vice industries like cigarettes, alcohol, and gambling tend to be recession-proof. They have profit strength. Companies that make consumer staples like diapers, drugs, toothpaste, and soap have profit strength. Johnson & Johnson, Procter & Gamble, and Kellogg are examples.
The other risk we avoid is business-related risk. There are an infinite number of problems that can cause a company's profits to dry up... from mistakes or accidents to changes in consumer preferences.
It's impossible to eliminate this risk. But there is a way to reduce it. And that's by only buying companies with long track records of profit strength. These are the best businesses. The easiest way to determine this is by looking at the company's dividend.
Companies return profits to shareholders by paying dividends. So if you're looking for safety, you should only buy companies with a long history of dividends payments, especially companies that have increased those dividends over many years or even decades. For example, Johnson & Johnson has raised its dividend for 49 consecutive years. Procter & Gamble has raised its dividend for 56 consecutive years.
In conclusion, if you only buy companies with stock price strength, low debt, and profit strength, you'll be buying the safest stock investments in the world.
And by the way... just because you're buying safe companies doesn't mean you can't make a lot of money. When I've looked back over my best investments, I always find the safest investments made me the most money.
Check out a few of Tom's recent ideas here:
"If your stock passes these two tests, it's safer than 99% of all stocks in the world."
"Buying stock this way is like going to the Nike Factory Outlet to buy your sneakers instead of going to Foot Locker," Tom writes. "You avoid paying a mark-up to the retailer – or, in this case, the stockbroker."
"You have many choices when it comes to buying gold bullion," Tom writes." You can buy gold jewelry... You can buy gold bars. They sell them in one-ounce, 10-ounce, or even 400-ounce bars. Or you can buy gold coins."
A BIG POTENTIAL MOVE AHEAD IN THE CURRENCY MARKET
For the euro bears out there: The euro is now "compressed"... So get ready for fireworks.
One of the market's biggest potential blowups is the European monetary union and its currency, the euro. Some union members, like Greece and Italy, are in dire financial straits... and many analysts (like our colleague Porter Stansberry), expect a crisis in the next year or two. This crisis would cause a big decline in the euro.
Traders betting on this decline have been teased for months. The euro peaked in May... and has been whipping up and down for months... with little headway made up or down. But note a special annotation on our chart today – a 15-month chart of the euro. Note how the euro's week-to-week volatility is drying up. Traders call this price action "compression."
We don't place much stock in conventional chart reading at DailyWealth. But over the years, we've seen many of these "compressed" situations resolve themselves with big moves, higher or lower. We've seen it happen so many times, we liken the situation to a coiled spring. With all the debt trouble facing Europe, chances are good its currency springs to the downside.
In The Daily Crux