Top Picks 2020: American Express (AXP) and Mastercard (MA)

01/23/2020 5:00 am EST

Focus: FINANCIALS

John Reese

Founder and CEO, Validea.com And Validea Capital Management

In the stock market, there may not be such a thing as a truly conservative stock. Some stocks that look conservative, can get thrown out the window when things get tough, notes John Reese, editor of Validea.

With that being said, there are ways an investor can attempt to find what we’ll call “conservative compounders” which is a company that has shown the ability to continuously produce profits and above average returns on equity and capital.

These stocks also exhibit certain stock price and fundamental characteristics that help uncover lower volatility stocks that are appealing to the conservative investor. The combination of these two approaches is how we will source our conservative stock idea for 2020.

To start, we need a model for the “compounders” and for this we’ll take the Warren Buffett method. We have extracted the method outlined in the book Buffettology and computerized it.

That model, which looks for 10 years’ worth of consistent earnings, returns on equity, returns on capital and a bunch of other fundamental factors is the core of the strategy.

The model rewards companies with moats around their profits and are that more profitable than your average firm, and then it looks to select those companies where the stock price presents a fair and reasonable valuation.

Now we need a systematic selection process for the “conservative” portion of the model. For this, we will draw from research from Pim van Vliet, not a household name in the U.S., but in Europe he is a leading investment manager.

He is also the author of the book, High Returns From Low Risk, which demonstrated the effectiveness of selecting low volatility stocks and combing that with other fundamental factors, like how much cash was being returned to shareholders.

We can then effectively combine, or screen, these two models to give a short list of names we can look at. Something interesting emerged from that search: the two companies making the cut are also in Berkshire Hathaway’s actual portfolio.

Based on this approach, our conservative Top Pick for 2020 is a split between American Express (AXP) and MasterCard (MA). Both companies get high marks from the models on Validea, making them impressive conservative compounders. Plus, Buffett has major stakes in these companies.

That combined with a strong U.S. consumer and the increasing use of credit, along with attractive margins and sustainable growth figures, make these two stocks interesting conservative picks for the next 12 months.

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