The Secret to Finding Cheap World-Dominating Stocks
By Dan Ferris, editor, Extreme Value
August 21, 2008

Today, I'm going to let you in on a technique the world's greatest investors use to safely make 20%-plus returns for decades.

If you understand this simple idea, you'll know how to spot and buy stocks that do well in any market, at prices that'll help you make and keep a lot of money.

All you have to do is answer one question: What is a world-dominating company really worth?

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I found the answer. The market has made it very clear to anyone who cares to look.

A world-dominating business is generally the largest, most powerful company in its industry – like Wal-Mart, the largest retailer, or ExxonMobil, the largest oil company.

Most world dominators can raise prices to stay ahead of inflation, like Coca-Cola or Procter & Gamble. Or, like Wal-Mart and Exxon, they can use their enormous size to keep costs lower than everyone else in the industry.

Raising prices or being the lowest-cost provider means these world dominators tend to crush the competition. So they often generate enormous amounts of cash. This free cash flow is the money left over after paying all the bills, taxes, and interest payments.

Using three corporate buyouts of world-dominating businesses over the last three years, I've arrived at a general ballpark valuation. Different world dominators will certainly be worth less, some more. But this benchmark is a highly useful tool, one that can give you a clear competitive advantage in the market for big, consistent returns on stocks. Take a look...

In 2005, Procter & Gamble bought Gillette for about 30 times trailing free cash flow. Gillette is a huge brand. It has a 90% market share by value in some countries. Schick is a good competitor... But it'll always be a distant No. 2 to Gillette. Every day, 2 billion men wake up and most of them shave. Most of them choose Gillette.

Earlier this year, the Mars Company offered William Wrigley & Co a price that was also right around 30 times trailing free cash flow. Wrigley is the world's biggest maker and seller of chewing gum, and one of the most well-known brands on Earth: a true world dominator.

A few months after the Wrigley deal was announced, InBev offered to buy Anheuser-Busch. Anheuser's ticker symbol says it all: BUD. Budweiser's U.S. market share is around 48%, nearly half the U.S. beer market. It also owns other popular brand names like Michelob, Bass, Beck's, Kirin, Rolling Rock, and Lowenbrau.

Guess how much InBev's $70-a-share offer for BUD turned out to be... 28.4 times free cash flow. A bit shy of 30 times, but close enough.

The valuation of stocks isn't a science. It's an art built on numbers. So the general ballpark of 30 times trailing free cash flow is as close as we need to get.

Why 30 times free cash flow? Why such a high price?

The answer is simple. These businesses aren't likely to look very different a decade or two from now, because they dominate their markets. And though they're very large businesses, the chances are excellent they'll deliver enough growth to make the seemingly exorbitant price of 30 times free cash flow worth paying. If you can pay just 15-20 times free cash flow for these businesses, you're setting yourself up for years of incredible returns.

In 2007, Extreme Value readers bought Western Union, the world's biggest money transfer company and another world dominator. I recommended Western Union at around 21 times cash flow... pretty cheap, when you figure it's worth more than 30 times. We're up about 25%.

You should avoid just about every stock on the market today. But not the world dominators. These are the greatest businesses in the world, the stocks Warren Buffett buys and holds forever. Buffett owned Gillette when Procter & Gamble bought it, and now he owns Procter & Gamble. He owned BUD when InBev bought it, and he's becoming a minority equity holder in the Wrigley deal.

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Buying a world dominator "on sale" will give you ultimate confidence that you're going to make a profit. It takes out much of the uncertainty about your financial future. And it eliminates the guesswork most investors rely upon to pick stocks.

Good investing,

Editor's note: Dan Ferris is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

Sign up today to read more investment ideas from Dan Ferris.

TRAVELING TO EUROPE JUST GOT A LOT CHEAPER!

It didn't take long for our "bearish euro" call to come true.

Just a few weeks ago, Steve laid out the argument for a big fall in the pan-European currency. A currency tends to decline when its home region is suffering a weak economy. It also tends to fall when it gets pricey relative to other currencies... aka the "expensive hamburger effect."

The big fall took just two weeks to happen. Yesterday, the euro hit its lowest point in six months. It's down 5% since Steve made the call in DailyWealth – an enormous move for a major currency (Sjuggerud Confidential readers are up double-digits already in his recommended euro trade).

We wouldn't be surprised to see the euro enjoy a short-term bounce in response to this giant selloff. But in terms of the next year or two, expect this "cracking" of the euro's uptrend to get worse.