The incredible bull market fed by Ben Bernanke’s monetary stimulus has inflated the prices of many stocks well beyond their intrinsic value. Although few bargains remain, many investors cannot bring themselves to move to a full cash position; the market could continue its upward climb for another year or more, causing investors who stay on the sidelines to miss out.
The solution is not to buy the high-flying growth stocks that have been shooting skywards since late 2012. Instead, investors should allocate available cash toward great businesses selling at reasonable prices.
Great businesses will continue to generate substantial cash flow even if the economy turns down again, whereas growth at companies like Chipotle Mexican Grill, Inc. (NYSE:CMG) could easily stall out if the economy falls into another recession.
At the same time, investors who pay enormous multiples for great businesses will be sorry they did so; if you pay $30 for a company that reliably produces $1, you are set to lose a lot of money when the market crashes. However, paying $15 for $1 of reliable earnings is a great deal in this market. This is the kind of situation investors should be buying into today.
Three great businesses for reasonable prices
There are no amazing bargains in the great business arena today, but concentrating your portfolio on a few reasonably-priced businesses will lead to market-beating returns over the next couple of years.
The Coca-Cola Company (NYSE:KO) is one company that sells at a reasonable price. As the leading carbonated soft drink company, The Coca-Cola Company (NYSE:KO)’s brand is ubiquitous throughout the world. Its enormous distribution network cannot be replicated by any but the largest of competitors. As a result, the company’s cash flows are ample and growing.
The Coca-Cola Company (NYSE:KO) generated $1.73 per share in free cash flow over the last four quarters. At a recent price just below $41 per share, the stock trades at a 4.3% yield to trailing free cash flow. This does not sound impressive until you consider that the company has grown free cash flow per share at a 7% compound annual rate over the last decade.
What’s more, the company has increased share repurchases over the last few years. It now spends over $3 billion per year repurchasing stock. This will enable free cash flow per share to grow at a higher rate than cash flows over the next decade. When share repurchases and revenue growth are combined with the company’s $4.5 billion per year dividend, shareholder return may exceed 10%.