6 Criteria for Picking Great Stocks - And 6 Stocks That Make the Grade

Includes: AAPL, CMI, ETN, GOOG, JOY, V
by: Steve Reitmeister

We’ve come a long way in just two short years. The market has rebounded ferociously from the lows of March 2009 and there is a lot less talk of double dips.

More and more signs point to this being a solid economic recovery which should be good for stock investors. Yet it would be foolish to say that 2011 is without its share of risks.

So is your portfolio built to profit in the unique investment landscape that lies ahead?

If you're feeling a little uncertain about your current investment strategy, you're not alone. Many investors have watched the market rebound without a meaningful rebound in their financial well being. But, that’s not an excuse to leave it that way.

Now Is the Time to Act

There is no better time than now to re-build your portfolio to profit in the days ahead. If you have a stock selection process that has helped you outpace the market in years past…then feel free to stop reading this article because you are all set.

For the rest of you, might I suggest a process we use here at Zacks Investment Research that looks at 6 different factors. Each one individually will help you pick better stocks. However, when you combine them together it creates a huge advantage for the investor. This stock selection process is called the Zacks Method for Investing.

6 Criteria for Picking Great Stocks

(AKA: The Zacks Method for Investing)

  1. Valuation: Study after study proves that stocks with low valuations will outperform the market over the long haul. Therefore, we prefer companies that are trading with P/E’s and Price to Book (P/B) multiples below their peers. Again, the key is not a low valuation compared to the overall market, but low compared to companies in their industry.
  2. Management Effectiveness: We evaluate the fiscal health of the company, with a particular emphasis on how effectively it is managed. Our research shows that Return On Equity (ROE) is the best measure of this. So we seek out companies generating an ROE that is superior to their industry peers.
  3. Recent Analyst Upgrades: Our research also clearly shows that stocks that have recently received a recommendation upgrade from brokerage analysts will continue to outpace the market. Most of that benefit is felt in the short run. However, quite often a stock that receives one upgrade is likely to get more in the future which keeps pushing the stock higher.
  4. Best Industries: Even the best looking stock will underperform the market if it's in an out-of-favor industry. That is why we overweight stocks from the best industries, and sectors. The recommended way to determine which industries will outperform is by seeing the earnings estimate revisions for that group. Meaning if the companies within the industry are enjoying hefty earnings surprises leading to earnings estimate increases for the future…that is where you want to put your money.
  5. Attractive for the Long Term: Companies that have consistently topped earnings in the past are more likely to do it into the future. This consistency gives investors great comfort with the firm leading to expanding multiples. This will generate above average gains for investors as they enjoy share prices gains from earnings growth + multiple expansion.
  6. Timeliness: Academics proved long ago that companies that have positive earnings surprises will generally outperform for the next 9 months. Conversely companies that miss expectations will underperform for the next 9 months. This is known as the Post Earnings Announcement Drift (PEAD). Taking this idea a step further you will find that there is much more potency from the PEAD in the first 1 to 3 months after the earnings surprise. So concentrate your new stock selections with the companies that just experienced the biggest earnings surprises.

Like I shared earlier, each of these attributes in isolation will help you pick more profitable stocks. Combining the elements together significantly increase your odds to beat the market year after year.

6 Stocks That Make the Grade

I normally share 5 top stocks in my articles. But since I had 6 criteria for picking great stocks, then giving 6 picks had the right symmetry. And yes, these stocks blend the benefits of the criteria noted above.

  1. Apple (NASDAQ:AAPL): Probably the best run company in the world that continues to blow away earnings projections. Recent dip after massive earnings surprise gives a GREAT opportunity to load up on more of these shares that are probably worth over $500. (See more about that in this article: 5 Reasons Not to Worry About Apple).
  2. Cummins (NYSE:CMI): These guys are in the driver’s seat of a great long term growth trend in the transportation field. As the world economies expand they need more large transportation vehicles to move people and products. Cummins is a leader in making the engines that go into these vehicles.
  3. Eaton (NYSE:ETN): Eaton plays in many of the same hot growth markets as Cummins and a few others. Their management team has been the model of consistency and have emerged from the Great Recession in remarkable shape. Brokerage firm Robert Baird recently upgraded shares to Outperform with $130 price target because people don’t fully appreciate the earnings potential of the firm.
  4. Google (NASDAQ:GOOG): Let’s not belabor the point. Apple and Google have their hands in most of the exciting growth areas in the technology field. No sense owning just one of them. Buy’em both.
  5. Joy Global (JOYG): Developing nations need more and more resources to build out their infrastructures. That leads to more mining of those resources. And that leads to more purchases of mining equipment from companies like JOYG.
  6. Visa (NYSE:V): Once the government regulation cloud is lifted from the credit card industry, then we can get back to focusing on the positive long term trends for electronic financial transactions. And within that realm, Visa is the clear leader.

Disclosure: I am long AAPL, CMI, ETN, GOOG, JOYG, V.