How The NBA Finals Can Boost Your Roth IRA

If, like our family, you purchase individual stocks within your Roth IRA, then watching the NBA Finals can provide a serious boost to your retirement savings.

How's that?

Because if you pay close attention to the commercials, you'll see a wall-to-wall display of some not-so-hidden stock market gems with a history of trouncing the market averages.

But before we go any further, let's see what's required to beat the market.

Beating The Street

Contrary to conventional wisdom, most Main Street investors are more than capable of generating annual returns in excess of the common benchmarks such as the S&P 500 and the Dow Jones Industrial Average.

True, Wall Street has more resources, brain power, and access to information than most individual investors. But fortunately for you, you don't need a stratospheric IQ or insider information to consistently outpace the market indices. After all, I know a lot of highly intelligent, well-connected people with underperforming investment portfolios.

So if you don't need above average intelligence or insider information, what do you need?

Two things:

1) Patience

and

2) Discipline

If you have patience and discipline, you have an enormous advantage on Wall Street, because fund managers literally can not afford to be either - their clients don't let them!

Once you realize this truth, you discover that achieving above average market returns is quite simple. But don't confuse simple with easy. In practice, beating the market is quite difficult, but only because most people insist on making the simple complex.

Need an example? Here's one that highlights the importance of the NBA Finals.

20 Years Ago This Week...

Twenty years ago this week, I was watching the NBA Finals. Michael Jordan and the Chicago Bulls were taking on Clyde "The Glide" Drexler and the Portland Trailblazers.

Like most kids my age, I loved watching Jordan, but I should've paid far more attention to the commercials than Jordan's jump shot. Why?

Because if I had invested in the companies which advertised during the NBA Finals, I would've done very well over the past 20 years.

For instance, let's take just the commercials featuring Michael Jordan. I remember them clearly - Nike (NKE), Gatorade (PEP), and McDonald's (MCD). And let's not forget the Coca-Cola (KO) featured in those McDonald's commercials.

Back in 1992, Nike, Gatorade, McDonald's, and Coca-Cola were all household names. In fact, you'd be hard pressed to find anyone unfamilar with these companies and their products.

Nevertheless, everyone familar with these companies had the same opportunity to buy them back in 1992 and generate the following returns:

All four of these companies beat the S&P 500 over a 20 year period, two of them (Nike and McDonald's) by a substantial margin.

While a $1,000 invested in the S&P 500 would have yielded $3,281.80 over a 20 year period, here's what you would have if you had invested in any of the above stocks:

• Coca-Cola (KO) - $3,596.70 (9.5% more)
• Pepsico (PEP) - $3,866.70 (17.8% more)
• McDonald's (MCD) - $8,066.10 (145.7% more)
• Nike (NKE) - $14,107.70 (329.8% more)

See how investing can be simple? All you had to do was buy these well-known consumer brand companies, hold them for 20 years, and you would have trounced the market average!

But making the decision to buy these stocks and patiently hold them for 20 years, riding the highs and lows with great discipline, is not easy. Emotion makes it difficult. After all, investing is supposed to be complex. Shouldn't you be "doing something," and aren't blue-chip stocks like these "boring"?

Sometimes the smartest move you can make is doing nothing, and I'll take a boring 1,000% return on Nike any day!

Patience and Discipline

To further illustrate the impact of patience and discipline, let's look at the same stocks over a longer period - let's say 30 years:

While a $1,000 invested in the S&P 500 would have yielded $12,535.10 over a 30 year period, here's what our stocks returned:

• Coca-Cola (KO) - $53,730.20 (328.6% more)
• Pepsico (PEP) - $52,982.60 (322.6% more)
• McDonald's (MCD) - $32,752.80 (161.2% more)
• Nike (NKE) - $109,526.90 (773.7% more)

Again, every one of these stocks was well-known in 1982, yet their collective returns outpaced the market by a wide margin. Why?

Consumer Brands and Their Unique Qualities

Each of the above mentioned companies can be classified as a consumer brand company, meaning they sell branded products directly to their consumers. Branded businesses compete on the basis of perceived quality as opposed to commodity businesses which compete mainly on price.

Consumer brand companies have several unique qualities that make them excellent businesses. Here are just a few:

1) Low Capital Requirements - Great companies don't have to continually reinvest large amounts of money in new capital and infrastructure, so they tend to get higher returns on capital. For instance, a 12-ounce can of Coke has changed relatively little in the past 20 to 30 years - aside from New Coke ☺. So it's not necessary to constantly spend new money updating and re-engineering the production line. Contrast this example with an auto company, which constantly reinvents its product. Auto manufacturers do have a need for constant captial expenditures, updating and reengineering their assembly line with each new release.

2) High Barriers To Entry - Great companies also erect high barriers to entry, so it becomes difficult to compete against them. This limits their competition. For instance, Warren Buffett once estimated that if you gave him $100 billion to build a competitor to Coca-Cola, he might well give up before trying. That's how high the barrier to entry is. High barriers equal less competition, and less competition opens the door for greater profitability.

3) Brand Loyalty - Great companies generate brand loyalty among their customers. When customers are loyal to your brand, they won't easily switch to a competitor's product due to a slight increase in the price of your product. As a result, companies with brand loyalty are able to increase their prices faster than inflation, keeping their profit margins intact - and hopefully, expanding their profitability over time. Brand loyalty also results in consistent sales over long periods of time.

All of these factors combined in a single company create a unique business able to sell the same product (or variation thereof) over and over and over again. And if these products are low-cost and regularly consumed, even economic downturns don't seem to effect their sales.

If you understand the qualities of a great consumer brand (and there are far more than I can tackle in this short post), then you already have half your answer to the following question...

Why Do Some Blue-Chips Outperform the Market?

There are a lot of great publicly traded companies, but not all of them beat the market. So how do you find the one's that do? Here's a couple of traits to look for:

1) Consistency - Find those great businesses with a history of consistent annual growth in categories such as earnings, dividends, sales revenue, and return on equity. The annual growth doesn't have to be massive, just consistent. Remember, the tortoise beat the hare!

2) Reasonable Valuations - Find great businesses with a history of consistent earnings and buy them at a reasonable price.

That last trait is the secret to great investment returns. This is where most people trip up. Many people chase after hot "growth stocks" in an effort to get to big returns, but these are often the worst investments. Why? Because most people overpay for them!

For example, if Company A has 20% earnings growth, and Company B has 8% earnings growth, which one should you buy?

Most people would say Company A, but you need one more piece of information before you make your decision - what are the prices of Company A and Company B?

If Company A is already priced for 20% earnings growth, but Company B is priced for 6% earnings growth, you should buy Company B. Of course, ideally you'll be able to buy Company A when it's priced for 10% earnings growth!

But you get the point. The price you pay determines your rate of return, NOT earnings growth.

This is why Coca-Cola, Pepsico, McDonald's, and Nike were so successful in beating the market over the past 20 and 30 years.

As well-known companies, most investors viewed them as "boring, stodgy, low-growth" stocks. They weren't "sexy" enough to warrant attention. Instead, they were derided as "mature" companies. Yet, over time, they consistently beat Wall Street earnings expectations and generated mamouth returns for investors.

So what's the ultimate lesson here? Pay attention to the stocks that are right under your nose. Have the patience and discipline to buy great companies at great prices and hold them as long as they deliver consistent earnings growth. Over the long haul, you'll be rewarded.

This Year's NBA Finals

So last night, I found myself once again watching the NBA Finals. This time, LaBron James and the Miami Heat defeated Kevin Durant and the Oklahoma City Thunder for the title.

You may have watched this series yourself. Hopefully, you paid close attention to the commercials.

Why? Because the NBA targets the coveted 18 to 35 year old demographic. Hook those young people on your well-branded consumer product, and they'll be loyal customers for decades - buying your products over and over and over again, and paying slightly more each and every year for that priviledge.

That makes the NBA Finals the ideal venue for finding stocks to add to your watch list of potential long-term investments. And this rule applies to the upcoming NFL season as well, so start thinking about what stocks you should own over the next 20 years. Some of those names might be the same - Coca-Cola (KO), Gatorade (PEP), McDonald's (MCD), and Nike (NKE).

But some new names might catch your fancy as well - Buffalo Wild Wings (BWLD), Boston Beer (SAM), Under Armour (UA), or Visa (V).

Regardless of what stocks you have your eye on, you should consider buying great companies and holding them for a long time. The above charts alone confirm the wisdom of doing so. Just make sure you don't overpay for them. And remember, with your Roth IRA, you can reinvest the dividends from those stocks tax-free each quarter and compound your annual returns even further. So when next year comes around, I highly encourage you to watch the NBA Finals!