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Monday, July 6, 2009

The 4 Secrets of Top Stocks

By the end of this article you're going have two stock ideas and a list of four traits that you should look for in every stock before you buy it. Indeed, if you find them all together at the same time, you will have an all-but-guaranteed market-beating long-term investment on your hands.

The problem is this: It's extremely rare to find all four of these traits together. The good news is that if it's ever going to happen, now -- as we wallow in the most treacherous bear market of the past 80 years -- is the most likely time.

One framework for success
David Winters is one of the market's top investors. He had a successful career as the chief investment officer at Franklin Mutual before setting up his own shop, Wintergreen, in 2005. Since then, his flagship Wintergreen Fund (WGRNX) has outpaced the market by three percentage points annually.

The secret to his success is no secret at all. In fact, Wintergreen has gone on record over and over again saying that when he looks at stocks, he's looking for the "trifecta." That's a ...

1) Good business ...
2) With good management ...
3) Selling at a low price.

For Winters, this checklist has led to sizeable investments in Wynn Resorts (Nasdaq: WYNN), Canadian Natural Resources (NYSE: CNQ), and Goldman Sachs (NYSE: GS).

But there's a rub
Yet you'll notice something about those three Wintergreen holdings. By most accounts they're good businesses run by good people selling for cheap in today's market. But they all face significant industry headwinds.

Wynn, for example, runs luxury hotels and casinos in Las Vegas and Macau. Traffic in both places is down substantially due to the global economic downturn, as well as recent Chinese visa restrictions in Macau.

Canadian Natural Resources is an oil exploration and production company. Unless you've been living under a rock, you know that oil prices have been sledge-hammered.

And Goldman Sachs is a financial firm that recently converted into a bank holding company. You're probably aware that it's not a good time to be a financial firm.

Alas, this is logical
This is not to say that David Winters is a daft investor who ignored these risks. Rather, it instead points out how difficult it is to find a good business with good management selling at a low price unless something is wrong. And that "something" is usually an industrywide headwind or some other big-picture issue such as looming regulation or litigation.

And while Winters has the patience to collect good businesses with good management at cheap prices and wait around for the big picture issue to resolve itself, you may not.

How you can one-up Winters
Thanks to the recent stock market decline, you can now find good businesses with good management selling at low prices that are going to benefit significant macroeconomic tailwinds if you know the right places to look.

And that's the fourth trait for your checklist: Is there a tailwind, a catalyst, or a rising tide that will help this otherwise superior-on-all-fronts stock idea achieve truly outstanding returns?

Ride this wave to profits
Consider, for example, if you'd rather own eBay (Nasdaq: EBAY) or MercadoLibre (Nasdaq: MELI). Both are leaders in e-commerce, both are run by pretty good teams, and both look pretty cheap (eBay at 6 times EBITDA and MercadoLibre relative to its growth prospects).

But while eBay derives 75% of its revenue from the developed and deeply troubled economies of the U.S., the U.K., and Germany, MercadoLibre does more than 50% of its business in Brazil -- an emerging regional power that should continue to post positive GDP growth and benefit in the coming inflationary environment, thanks to its immense reserves of natural resources.

With eBay, you have headwinds; with MercadoLibre, you have tailwinds.

Similarly, would you rather own Altria (NYSE: MO) or Philip Morris International (NYSE: PM)? The companies are in the same business, have management teams from the same pedigree, and while Altria is selling at a slightly higher yield and a slightly lower earnings multiple, both seem like good deals.

Yet with Altria, you're 100% focused on the U.S. -- a market that's seeing annual cigarette consumption declines as well as rising taxes, increased regulation, and outright bans on smoking. Philip Morris International, on the other hand, is globally diversifed and dominant in emerging markets like Indonesia, where cigarette consumption is on the rise and consumers continue to switch from lower-priced cigarettes to higher-priced Marlboros.

Again, do you want to bet against the headwinds or with the tailwinds?

Go with the flow
The answer should be obvious, and while companies benefiting from macroeconomic tailwinds tend to sell at a premium to their challenged counterparts, the recent market decline has narrowed that premium and put many top companies on sale for cheap.

That's why we're so excited to be picking stocks today at Motley Fool Global Gains, and why we're particularly excited to be in China meeting with a number of promising companies. China, after all, has the potential to be the biggest global tailwind of them all, and the companies that benefit the most will be domestic Chinese firms like the ones we're meeting with all across the country.

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