Stocks to Watch

Below is an update of the list of stocks I'd like to own* at the right price. From my point of view, the shares listed are attractive long-term investments below the prices (preferably well below, of course) I've indicated. Unlike when I first published this list most have become too expensive to buy. A symptom of a happier market.

Naturally, the objective is to buy these significantly below the maximum prices I've indicated I'd pay when the opportunity presents itself. So, for now, some patience is needed then decisiveness if there's an opportunity.

Since creating the initial Stocks to Watch list, none of the 20+ stocks on the list is selling lower. Johnson & Johnson (JNJ) is the worst performer at an 8% total return. All others have returned more (in some cases much more). I don't view that as great news.  It'd be safer and easier to invest right now if some of these stocks were selling at much lower prices. The further below intrinsic value the better. Not only does it allow accumulation of more shares below intrinsic value to happen, the company itself can use excess free cash flow to do the same.

"When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases." - Warren Buffett in the 1984 Berkshire Hathaway Shareholder Letter

Johnson &  Johnson (JNJ) is selling slightly higher than when I first posted it but remains the only stock that still sells below the max. price I'd be willing to pay for it (some others are border line). Pepsi (PEP) is a close call as I've raised what I'd be willing to pay from $ 60/share to $ 65/share. Others on the list are fine businesses and, in my view, if held for a long enough period are likely to create solid returns for shareholders even when bought at current prices.  I just prefer a higher margin of safety.

Those below the dashed line are companies I like but prevailing prices have become too high. 

As always, the stocks in bold have two things in common. They are:

1) currently owned by Berkshire Hathaway (as of 9/30/10) and,
2) selling below the price that Warren Buffett paid in recent years.

There are several other Berkshire Hathaway holdings on this list but they don't have the 2nd thing going for them.

This list is intended to remain very stable over time with few additions or deletions. I never have a "price target" (A term you'll hear all too often on Wall Street and business news). I'm looking to buy a great business at a reasonable price then allow it to compound in value over a very long time frame. What drives the buy/sell behavior will be when Mr. Market goes to extremes. So these are all intended to be long-term investments. A ten year horizon or longer. No trades here.

All of the stocks on the current list were part of the original Stocks to Watch list unless otherwise noted.

Stock|Max Price I'd Pay|Recent Price (12-31-10)
NSC|54.00|62.82 - added to the original list on 12/17/09
MCD|63.00|76.76 - added to the original list on 12/17/09

Stocks removed from the list:
  • BNI - I liked purchasing BNI up to $ 80/share. It was bought out by Berkshire Hathaway for $ 100/share in late 2009. Deal closed in early 2010.
The max price I'd pay takes into account an acceptable margin of safety**. That margin of safety differs for each company.

In other words, I believe these are intrinsically worth quite a bit more than the max price I've indicated in this post and in prior Stocks to Watch posts. I also believe these companies generally have favorable long-term economics (i.e. high and durable return on capital) and, as a result, intrinsic values will grow over time. Of course, I may be wrong about the core economics and that margin of safety could provide insufficient protection against a loss. Still, a year from now I would expect to be willing to pay more for many of these based upon each company's intrinsic value growth over that time frame.

Though I could surely be wrong, I consider these stocks appropriate for my own portfolio (not someone else's) given my understanding of the downside risks and potential rewards. It doesn't make sense for others unless they do their own research and reach similar conclusions.

So, even if not wildly overvalued, these stocks are mostly too expensive to buy right now. The margin of safety is too narrow for my money. There has been no shortage of chances to buy these at a discount to value in the not too distant past. That was the time to act. The risk of missing the chance to own a well understood investment when a fair price is available (error of omission) can be more costly than suffering a short-term paper loss (though, due to loss aversion, many focus much more on the latter). Hopefully, at least some of them will get cheap again.

Here are some thoughts on errors of omission by Buffett from an article in The Motley Fool.

Also, from the 2008 Annual Letter to Shareholders:

"During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt... Furthermore, I made some errors of omission, sucking my thumb when new facts came in." - Warren Buffett

In other words, not buying what's attractively valued to avoid short-term paper losses is far from a perfect solution with your best long-term investment ideas.

To  me, if an investment is initially bought at a fair price, and is likely to increase substantially in intrinsic value over 20 years, it makes no sense to be bothered by a temporary paper loss. Of course, make a misjudgment on the quality of a business and that paper loss becomes a real one (error of commission).

There is no perfect answer to this problem. When highly confident that a great business is available at a fair price it's important to accumulate enough while the window of opportunity exists. Sometimes accepting the risk of short-term losses is necessary to make sure a meaningful stake is acquired.

Finally, above average long-term returns at lower risk is the objective. Performance over the complete market cycle without needing to trade. For me, performance in a down market matters more. I'd expect the above stocks to do better in that environment. Having said that, I am not tempted to trade from "defensive" to "cyclical" stocks (or anything similar to that approach) depending on the market environment. These are not trading cards, they're part ownership of businesses. I'll let others play that game as I believe this approach will do just fine in the long run even if it offers a little less excitement.


* This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to remain long the above positions (at least those that eventually become, or have previously become, cheap enough to buy) unless they sell for significantly higher than intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** The required margin of safety is naturally larger for a bank than for something like KO. When I make a mistake and misjudge a company's economics in a major way, the margin of safety may still not be sufficient. Judging the durability of the economics correctly matters most. If the economics remain intact but the stock goes down that is a very good thing in the long run.
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