10 Core Stocks

A M O T L E Y F O O L S P E C I A L R E P O R T

10 CORE STOCkS FOR YOuR

PORTFOLIO

2 The Motley Fool Special Report — Spring 2011 www.fool.com

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www.fool.com Special Report — Spring 2011 The Motley Fool 3

10 Core Stocks for Your Portfolio

check, check, and check. And for set-it-and-forget-it or risk-averse investors, you’ll find a bonus ETF recommendation from our resident Fool fund expert.

These are the kinds of companies that we seek and tirelessly follow in our flagship stock picking service, Motley Fool Stock Advisor. (In fact, some of them are actual recom-mendations we have made to our members, which you’ll see disclosed after each write-up.) And all are informed by some core beliefs that we hope will help guide you through your illustrious investing career:

1. Buy businesses, not stocks. Stocks are not just slips of paper (or more likely nowadays, electronic confirmation notices). When we buy shares of stock we become part owners of a living, breathing business. Charts, graphs, tea leaves, and that CNBC anchor’s latest rant tell only a sliver of the story (if that). As bona-fide business owners we look at the people running our company, the customers, the competitors, and the long-term prospects to guide our investment decisions.

2. Buy to hold. No, that’s not a typo. While buy “and” hold is a strategy to which we aspire, we’re never so wed to any recommendation where we hold onto it just to hold. Businesses change. Strategies falter. Managements make bad calls. Game-changing events can render a once-beloved company completely obsolete. So while our intention is to invest in companies whose stock can pass down to our grandkids’ grandkids, when our original investment thesis no longer stands true — or when a better opportunity arises — we sell.

3. Timing is everything. But not in the way you might think. We don’t “time the market.” But we firmly believe that time — a long-term investing time horizon measured in years (even decades), not minutes — is what separates great investors from the pack. Having the temperament to stick to it and to give your stock market investments ample time to compound is one key to building real wealth. The other key to stick-to-itiveness is continuing to add to your investments over time.

Before we regale you with our hand-picked list of core stocks, we’d like to point out something that all of us have in common (you, The Motley Fool analysts making these recommendations, and even our entire company): We are all individual investors. And every single one of us starts

Table of ConTenTS:

Microsoft . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4Dolby Labs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6MSCI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8Kinder Morgan Energy Partners . . . . . . . . . . . . . . . . 10Google . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Netflix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14BHP Billiton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16Lockheed Martin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18McDonald’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20Johnson & Johnson . . . . . . . . . . . . . . . . . . . . . . . . . . . 22Bonus ETF Pick: Vanguard Total Stock Market . . . 24

Portfolios are built from the ground up. At the foundation you need companies that are strong, durable, and resilient — complementary businesses chosen for their superiority in industry, innovation, global presence, and domestic dominance.

With more than 5,000 companies at your trading fingertips, selecting those to serve as the cornerstones of a well-rounded portfolio — and not just an assemblage of random stocks — can be daunting. So we’ve grabbed our hard hats and created a blueprint to help you break ground and build your investment dream house.

Here you’ll find companies that Motley Fool writers and analysts deem strong enough to anchor a long-term focused portfolio. These 10 companies (and a bonus ETF!) include:

• A ubiquitous fast-food chain that’s proving bullet-proof in any economic environment.

• A company that reinvented the entire home enter-tainment industry … and is still at it.

• Another that enhances your listening experience with sound technology that has become the standard in the electronics manufacturing field.

• An expanding business tailor-made for heavy metal fans — iron, lead, steel, zinc, copper connoisseurs, that is.

Looking for a few blue chips to round out your portfolio? Check. Tech, defense, energy or financial services? Check,

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at the very same place — making that very first trade. So, without further ado, fellow investors, let’s break ground and start building that portfolio.

MicrosoftbY Morgan HouSel

Company Microsoft (Nasdaq: MSFT)

What it does

Develops, manufactures, licenses, and supports a range of software products and services for various computing devices worldwide.

Recent price $26.67

Market cap $224 billion

P/E 11.38

TTM ROE 44%

Every few decades, a handful of companies make the leap from ambitious start-up, to fast-growing newcomer, to cultural icon, to established blue chip. In the past, Boeing, Ford, and McDonald’s have achieved such success. In recent history, the award for this achievement belongs to Microsoft (Nasdaq: MSFT), which I’m nominating as a top 10 core stock for your portfolio.

The businessMost of us are acutely aware of Microsoft’s products. Odds are 91% of you reading this are using at least one of them (that’s Microsoft’s share on the operating system market).

Here’s a snapshot of all its business divisions:

Segment

2010 Revenue (in billions)

2010 Operat-ing Profit (in billions)

Windows $17.8 $12.1

Server and tools $14.9 $5.0

Online services $2.2 ($2.4)

Microsoft business $18.9 $11.7

Entertainment and de-vices $8.1 $0.6

Source: Capital IQ, a division of Standard & Poor’s.

Microsoft’s financial success clearly relies on Windows and Microsoft Business. The first segment, Windows, is home to the software platforms that run most of your computers. The second, Microsoft Business, is where Microsoft Office (Word, Excel, PowerPoint, etc.) call home. You probably already knew that, so let’s dig deeper into the details.

Why it’s a core stockFor all of Microsoft’s well-know faults — its products are buggy, they’re clunky, they crash, they become virus-ridden

— it continues to thrive year after year. Why? I think the answer lies in a comment Warren Buffett made more than a decade ago:

In effect, the company has a royalty on a communica-tion stream that can do nothing but grow. It’s as if you were getting paid for every gallon of water starting in a small stream but with added amounts received as tribu-taries turned the stream into an Amazon. The toughest question is how hard to push prices.

He’s talking about Microsoft’s moat, which can’t be de-scribed as anything less than spectacular.

Take Microsoft Office: the business has a narrower moat relative to Windows, but it’s still extremely effective. More than 80% of Office sales are to businesses. Within busi-nesses, the key benefit of Office is its shareability. I can create a document and email it to you. You can edit it, send it to your boss, who then sends it to clients, who can open it up on their computer, and on and on. It’s wonderfully con-venient. And for this process to work without any hitches, everyone has to use Office. Don’t like the software? Too bad. In most fields, you have to if you want to be relevant.

This chain of mutual reliance has grown so powerful that nearly every business in the world has incorporated Office into its operations. And it’s likely to remain that way. It’s a very tough chain to break, and one that’s given Microsoft a staggeringly powerful moat.

The rewards of this moat are, of course, extraordinary finan-cial results. And Microsoft hasn’t just become a champion of profits, but more specifically cash flow.

Year 2010 2009 2008 2007 2006free Cash flow (in billions)

$22.1 $15.9 $18.4 $15.5 $12.8


Microsoft shells out $4.6 billion a year in dividends and consistently buys back twice that amount of its own stock. Add it up, and you get a company that returns some $14 billion to shareholders annually, with the ability to consis-tently and safely grow that sum year after year. For a stock with a $175 billion enterprise value, that’s an incredibly lucrative arrangement.

risksLike any and every investment, there are risks here. Microsoft’s moat is deep, but not impenetrable.

The biggest risks come from competitors Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG). Apple’s threats are real, but mostly in areas where Microsoft has a small pres-ence. Google, on the other hand, is likely the most menacing

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threat since its Google Docs are a direct run at Office, which is so key to Microsoft’s financial success.

These threats shouldn’t be pooh-poohed, but they don’t keep me up at night as a Microsoft shareholder. If Google’s office software does find traction, history shows it’s unlikely to be apocalyptic for Microsoft. The reason, again, is that puncturing Office’s moat requires swarms of users to switch at the same time. While you can save a file that’s compatible with Word using Google’s Docs, the key interface that users are acclimated to and works seamlessly with all features is still Office. Throw in the fact that many companies (again, 80% of Office’s sales) receive volume discounts for bun-dling Office with other Microsoft products, and incentives for switching decline further.

The closest comparative example to this is, I think, compe-tition between Visa (NYSE: V) and MasterCard (NYSE: MA) vs. American Express (NYSE: AXP) and Discover (NYSE: DFS). Visa and MasterCard dominate the card industry, while AmEx and Discover fight for scraps, despite business models that are by most accounts superior (they in-tegrate the entire card business, while Visa and MasterCard simply process transactions).

Why haven’t AmEx and Discover been able to take sizable market share away from Visa and MasterCard? Because just like the office software business, they have to convince many different parties to switch at the same time in order to become successful. If businesses don’t accept AmEx or Discover, it’s useless for consumers to demand them. And if consumers don’t demand them, it’s useless for businesses to accept them. That type of competitive business environ-ment makes gaining momentum against the established frontrunner — be it Visa and MasterCard, or Microsoft — exceedingly difficult, if not unattainable. Dominant first movers in these kinds of businesses tend to stay on top for a long, long time.

In sumMicrosoft’s moat is thick. Its profits are deep. Its competitors have their work cut out for them. All told, I think it deserves a spot as a core holding in your portfolio.

Disclosure: Fool contributor Morgan Housel owns shares of Microsoft. Discover Financial Services, Google, and Microsoft are Motley Fool Inside Value recommendations. Google is a Motley Fool Rule Breakers choice. Apple and Ford Motor are Motley Fool Stock Advisor recommenda-tions. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Google and Microsoft.


Dolby LabsbY rICH DuPreYDid you watch CNBC this morning? Did you listen to Bloomberg radio? Heck, did you see the latest Lindsay Lohan flick at the theater? If you’ve done any of these activities, you’ve no doubt heard what’s so special about Dolby Labs (NYSE: DLB), the leading purveyor of sound technology.

Company Dolby laboratories (NYSE: DLB)

What it does

Premier sound technology specialist in computer, broadcast, entertainment, and mobile applications.

recent price $51.26

Market cap $5.74 billion

forward P/e (next 12 months ePS) 17.4

roe 20.0%

Sources: Capital IQ, a division of Standard & Poor’s; Yahoo! Finance.

The businessWhile anyone with a stereo is probably familiar with the double-D logo, Dolby has extended its reach far beyond making listening to music a quality-time experience. The leading sound system license is now found in your computer, in movies, and increasingly on your mobile handset. It’s also reached into digital cinema, bringing you better-quality viewing along with leading 3-D technology expertise.

In its core field of crystal clear sound, however, it has little in the way of competition. DTS (Nasdaq: DTSI) and SRS Labs do offer competing technologies, and some audio-philes will even go so far as to say DTS’s quality surpasses that of Dolby (though my average tin ear can’t tell the difference). But at just a fraction of the size, and with a similarly small percentage of revenues, these peers are not a threat to Dolby’s dominance of the marketplace.

From ear to ear, Dolby’s sound technology is not only included but is also one of the standards manufacturers abide by. The big-screen TV sales bulge brought on by con-version from analog signals to digital broadcasts caused a similar bulge in Dolby’s revenues that more than offset the supposed death of the DVD. Along with Netflix (Nasdaq: NFLX), we’re still waiting for DVDs to become a thing of the past, and while Dolby does mention it as a risk (more on that later), the transition to streaming video is taking longer than the experts expected.

Why it’s a core stockDolby is the standard of standards. Its technology is needed in just about every piece of audio equipment that exists in

your local electronics superstore, but is also part and parcel of your movie-viewing experience, no matter if that’s on the big screen or the little one in your living room. The players and the disks themselves carry Dolby’s codecs.

The licensing of its codecs provides Dolby with some huge margins: Gross margins exceed 85%, operating margins are close to 50%, and net margins exceed 30%. Those are numbers similar to what you’ll find Microsoft (Nasdaq: MSFT) producing, and with Dolby included in virtually every version of the software giant’s Windows 7 operating system (and XP and Vista before that), Dolby benefits as Microsoft grows. Returns on invested capital are very high as sales have grown at a torrid pace.

Yet if all Dolby had was the U.S. market, there might be some concern with saturation eventually eroding its profit potential. International markets, however, are providing Dolby with its next leg up in expansion. Attach rates for Dolby’s technology with European TV sales are expected to exceed 80% this year, and are starting a similar ramp up in Asia as those countries adopt Dolby formats for digital TV standards. In a few years, China will also force its citizens to migrate to a digital signal. Today, Dolby claims to be found on half of the world’s TV shipments. The other half provides the sound system specialist with potentially huge growth possibilities.

risksThe risks to a Dolby investment are more short term in nature than long term. Intel (Nasdaq: INTC) has warned of a coming slowdown in PC sales, and the iPad from Apple (Nasdaq: AAPL) is expected to cannibalize the PC market to a growing extent. Yet it’s a normal cycle for the industry, one Dolby has been through many times and will likely survive this time as well.

There’s also the eventual demise of the DVD. Yes, sooner or later, the disk will be largely supplanted by streaming video in all its iterations. It seems doubtful now that Blu-ray will stem the losses (and Dolby’s a standard on those hi-def disks, too), but Dolby’s presence in TV, set-top boxes, and in the movies themselves will ensure that it remains relevant no matter how we receive our pictures.

Finally, there’s the large overhang of Ray Dolby’s owner-ship interest. At age 77, he may start to convert more of his class B shares, which represent a 53% ownership interest in the company, for publicly traded class A shares for liquidity or estate planning purposes. But with such a large slug of stock still in his possession, the founder’s interests are closely aligned with those of current shareholders.

In sumFrom audio and TV to digital cinema and mobile handset


technology, Dolby Labs is part of the experience. Its tech-nology is being found in more and more mobile handsets belonging to Nokia (NYSE: NOK), LG, and NTT DoCoMo. The games we play, the movies we watch, and the sounds we hear are all made better through Dolby magic.

At 20 times last year’s earnings, though, Dolby’s not exactly cheap. While it makes money hand over fist, it’s expected that as the industry leader, it will always carry a premium. But there’s no reason an investor needs to take a full helping of the stock at this price. Nibbling here and there and waiting for the stock to sound some further opportunistic depths would be a better way to turn up the volume on Dolby stock. Disclosure: Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. Dolby Laboratories, Apple, and Netflix are Motley Fool Stock Advisor choices. Intel, Microsoft, and Nokia are Motley Fool Inside Value picks. Motley Fool Options has recommended buying calls on Intel and a diagonal call position on Microsoft. The Fool owns shares of Intel and Microsoft.


MSCIbY alex DuMorTIer If you’re reading this, chances are you follow your portfolio more closely than the average investor, and I expect you track your returns against those of a stock market index such as the S&P 500. For professional investors, there are no two ways about it — they live and die by their performance rela-tive to their benchmark index. MSCI (NYSE: MSCI) is one of the heavyweights when it comes to providing these investors with a full range of indices; the firm calculates values for some 120,000 equity indices daily!

Company MSCI (NYSE: MSCI)

What it does

Provides index data and equity risk management solutions to professional investors.

recent price $36.16Market Cap $4.3 billionP/e (next 12 months’ ePS) 18.6roe 11.6%


The businessBut offering indices as performance measurement tools is not the only way to monetize them; MSCI also licenses them so that exchange-traded fund (ETF) providers such as BlackRock’s (NYSE: BLK) iShares unit can offer ETFs based on the same. For their trouble, MSCI is remunerated on the basis of the assets under management (AUM).

At the end of August, AUM in ETFs linked to MSCI indices totaled $259 billion. The index with the highest associated assets is the MSCI Emerging Markets Index, which ac-counts for more than a quarter of the total.

MSCI’s major competitors in the index business are Dow Jones (a unit of News Corp. (Nasdaq: NWS)), Standard & Poor’s (a division of McGraw-Hill (NYSE: MHP)), Russell Investment Group, and FTSE International.

MSCI’s other main business is Equity Portfolio Analytics, which it inherited from its 2004 acquisition of Barra — the offerings in this area are still branded under the Barra name. Barra’s equity return model enables investors to optimize their portfolios by breaking stock returns into a set of common factors (style, industry, etc.). The model has gained significant acceptance, to the point where at least one of MSCI’s competitors in this area, FactSet Research Systems (NYSE: FDS), has integrated Barra risk data within its own application. Better yet, asset owners — that is, fund managers’ end clients — often request Barra risk measurement data when they are selecting investment managers.

Why it’s a core stockDefensible franchise: By definition, when you are hunting for a “core” stock for your portfolio, your first priority must be to ensure that the company has a sustainable competitive advantage. A core stock is one you expect to hold in your portfolio for years to come, and only a lasting competitive advantage can provide above-normal returns over this extended holding period.

Imagine if you had to replicate — from scratch — MSCI’s comprehensive database of worldwide indices and risk data. In some cases, you’d be required to reproduce indices that go back more than 40 years. Do you think that would cheap or easy to do? Of course not! It’s an undertaking that would require substantial time, effort, and the sort of expertise that you don’t accumulate overnight. MSCI itself did not appear ex nihilo — it was spun out of Morgan Stanley (NYSE: MS) in 2007.

Replicating these assets is a formidable barrier to entry that protects MSCI’s franchise and enables it to earn high returns on capital, year in and year out.

Recurring revenues with high retention rates: The vast majority of MSCI’s revenues are tied to recurring annual subscriptions. These revenues tend to be very “sticky”: MSCI’s average aggregate retention rate over the past three fiscal years was 91%. Combine both these characteristics, and you have a highly enviable revenue model.

risksRecently, a European fund manager at BlackRock (which just happens to be MSCI’s largest customer), declared that the “cult of equity” is dead. If that does turn out to be the case, it won’t be good news for MSCI, with the bulk of its revenues tied to the management of equity portfolios. Although I think we are witnessing a shift from equities toward fixed income, I also think the report of the death of equities is an exaggeration. Still, it is worth keeping this phenomenon in mind in tracking MSCI’s results over the next several quarters.

In sumAt 18.6 times the consensus estimate for the next 12 months’ earnings, one would be hard-pressed to call MSCI cheap.

As such, I don’t recommend jumping into this stock with both feet at these levels. There is nothing wrong with dip-ping your toe in and opening a small position, but this is a core stock, so there is no hurry to own it. If you expect these shares to anchor your portfolio for several years, you can afford to be patient and opportunistic in building your position. High-quality franchises like MSCI will almost


never look cheap, but if the current multiple falls a bit the shares would certainly warrant a more serious buying com-mitment.

Disclosure: Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this ar-ticle. BlackRock is a Motley Fool Inside Value pick. FactSet Research Systems is a Motley Fool Rule Breakers recom-mendation.


Kinder Morgan Energy PartnersbY CHuCk SaleTTaIf you’re looking for a company you can buy, hold, and perhaps never need to sell, you’ll want one with a strong economic moat, to assure it has long-term staying power. You’ll also want one that pays its owners well. After all, the only ways to make money off a stock are through dividends or through selling, and if you’re selling, the stock is hardly a core investment.

Kinder Morgan Energy Partners (NYSE: KMP) is one of the few companies that hit both criteria. With an impres-sive (and covered by operating cash flows) 6.3% yield, its distribution currently beats highly rated bonds. And since what it does is about the closest you can get to a “tollbooth” operation, it’s more or less is in the business of digging its own moats. Those two factors make it an extremely attrac-tive long-term holding.

Company kinder Morgan energy Partners (NYSE: KMP)

What it doesThe company owns energy pipe-lines and storage facilities.

recent Price $73.07

Market Cap $22.9 billion

P/e ratio 51.5

roe 19.1%

Data from Capital IQ, a division of Standard & Poor’s, and Yahoo! Finance.

The businessKinder Morgan Energy Partners along with its conjoined twin, Kinder Morgan Management (NYSE: KMR), trans-ports energy and energy-related products. In essence, it’s an oil and gas pipeline company that builds, owns, and operates much of the infrastructure that moves around the energy that powers our economy.

In addition to its own pipelines, Kinder Morgan partners with others in some cases. Recently, it completed the giant REX natural gas pipeline linking Western Colorado with Eastern Ohio, where it partnered with ConocoPhillips (NYSE: COP) and Sempra (NYSE: SRE). Between the pipelines it exclusively owns and the ones it shares with partners, Kinder Morgan is one of the largest companies in its line of business on the continent.

And if you do happen to like the oil production business, Kinder Morgan also claims to be the second largest oil producer in Texas.

Why it’s a core stockRefiners like Valero (NYSE: VLO) are exposed to market

risk based on the crack spread (the difference between the price of oil and the price of gasoline). Drillers like Transocean (NYSE: RIG) are heavily dependent on high oil prices to spur demand and high rates on their services and equipment. And even integrated giants like ExxonMobil (NYSE: XOM) prefer to see high oil prices in order to get good returns on their investments.

But pipeline companies like Kinder Morgan? They earn their revenues more on the quantity of oil that passes through their infrastructure, rather than its price. In addition, the business is very capital-intensive due to long pipeline and expensive right-of-way acquisition costs. In addition, it has a huge NIMBY (Not in My Backyard!) factor attached to it. Those two factors often scare away competition, so once one pipeline sets up, it’s unlikely to see many others pop up locally.

Yet what ultimately makes it such an attractive business is that once a pipeline is set up, it’s a significantly cheaper way to move oil than, say, trucking it around the country.

risksAs a company with lots of flammable and toxic liquids moving around its infrastructure, the occasional explosion or leak can have nasty consequences. While nothing from Kinder Morgan has risen quite to the level of BP’s oil spill, there have been occasional fatalities. As an investor, you face headline risk whenever there’s a disaster, and a large enough one could result in permanent loss of capital.

From a financial point of view, the company’s structure as a partnership adds risk as well. As a partnership, its unit holders are personally taxed based on the company’s income, rather than just on the dividends they receive. As a result, to attract investors, Kinder Morgan Energy Partners typically pays out more than it technically reports as earn-ings.

While its payout tends to be covered by its operating cash flows, such a high distribution level leaves the company with little to reinvest. Because of this, the company regu-larly taps the financial markets and dilutes its existing unit holders to get the capital it needs to expand. As long as it can successfully invest that capital at high rates of return, existing unit holders should do fine, but if it can’t, those units can stumble.

In sumIf you’re looking for an investment that pays you well while you own it and delivers a service that’s critical to our modern life, you could do far worse than Kinder Morgan Energy Partners. As long as we need oil and natural gas, and as long as the fields that produce it are far away from major population centers that demand it, there will be a need for


pipelines like the ones it owns.

Disclosure: At the time of publication, Fool contributor Chuck Saletta owned shares of Kinder Morgan Management, and Chuck’s wife owned shares of Valero. The Fool owns shares of ExxonMobil.


GooglebY TIM beYerS The next time someone tries to tell you that search is a wide-open business and that the tools we use today will be dead and buried within a few years, do this:

Blink.

That’s right, blink. Then say, “Google (Nasdaq: GOOG) just performed 3,832 searches. Yahoo! (Nasdaq: YHOO) performed 994, and Bing performed 639.” That’s what a market mammoth looks like when you break it down to its atomic parts.

On a bigger scale, here’s what the business looks like:

Company google (Nasdaq: GOOG)

What it does

Google is the search engine market leader, owner of YouTube, and an increasingly popular deliverer of cloud-computing software.

recent price $611.27

Market cap $196.5 billion

forward P/e (next 12 months) 15.2

return on equity 20.7%

Source: Capital IQ, a division of Standard & Poor’s. Data current as of Feb. 25.

The businessGoogle is search, and search is Google. All told, it’s a busi-ness that collects more than $26 billion in revenue annually. Most of that from a simple, clean, white Web page with a box where you and I enter phrases and questions — 3,832 questions and phrases every second, to be specific.

Except it isn’t that simple. See, the way Big G defines search is very different from how you define search. To Google, every piece of data that exists has to be categorized and indexed in some way. A Gmail label is a search string; it’s a way of categorizing an email in your inbox. But don’t take my word for it. See for yourself:

Each Google product is built on search in some meaningful way. Consider:

• Every YouTube playlist is a search string.

• Your Google Buzz feed is the result of searching the posts of those you follow.

• Each iGoogle page is fed by multiple searches for certain types of data (e.g., your email, your video playlists, your places, companies you follow, and so on).

• Every spreadsheet, doodle, presentation, and docu-

ment in Google Docs is indexed so that it can be accessed from anywhere on the Web. How? Using search.

The Web doesn’t work without search, which means it doesn’t work without Google.

Why it’s a core stockCompetitors would say that’s ludicrous, but ask yourself: How many have tried and failed to overcome Google’s search lead? Even technophobes Warren Buffett and Charlie Munger see how wide Big G’s moat is.

Then again, it’s difficult to miss the numbers. Combined, Yahoo! (Nasdaq: YHOO) and Microsoft (Nasdaq: MSFT) still account for less than half the searches Google does. Ask.com barely registers anymore, and AOL (NYSE: AOL) is becoming a content company — more a competitor to Google News than Google search.

Even in China, where Baidu (Nasdaq: BIDU) rules, the pos-sibility of Google stopping work on indexing the contents of the Sino superpower’s portion of the Web gave pause to regulators there. The Big G is that important.

Google is also a fierce competitor that has perfected the art of fast and cheap failure. You know the list of failed projects. Dodgeball (supplanted by Foursquare), Google Notebook (supplanted by Evernote), Jaiku (supplanted by Twitter), and Google Video (replaced by YouTube). How many of these failures have materially affected Google’s earnings and cash flow? How about zero? Over the past two years:

• Revenue is up an average of 15.6% a year.

• Normalized earnings have improved by an average of 22.2% annually.

• Free cash flow is up more than 150% annually.

• And the stock is up about 75%.

risksBut Google isn’t without risks. For as much as the Big G seems to have perfected text-based search, it has no answer for the sort of social search that Facebook and Twitter supply. Not yet, anyway. (CEO Eric Schmidt formerly con-firmed in media reports that a social search project called Google Me could debut soon.)

Connectivity is also an issue. Anything that gets in the way of Google getting in front of users is a problem in that it would prevent the company from collecting the data it needs to present you with meaningful, revenue-generating ads. This is why Android is so important, and why Apple (Nasdaq: AAPL) and its iPhone and iPad are so dangerous.


In sumWinning from here won’t be easy because of increased competition with Apple, Facebook, Microsoft, and Nokia, among others, but new CEO Larry Page expects to bring an even more innovative edge to Google in the coming years. If he’s right, outsized profits will follow.

Disclosure: Fool contributor Tim Beyers had stock and options positions in Apple and a stock position in Google at the time of publication. Apple is a Motley Fool Stock Advisor selection. Baidu and Google are Motley Fool Rule Breakers recommendations. Google and Microsoft are Motley Fool Inside Value picks. Motley Fool Options has recommended a diagonal call position in Microsoft. The Motley Fool owns shares of Google and Microsoft.


NetflixbY anDerS bYlunD

Company netflix (Nasdaq: NFLX)

What it does

Netflix turned the movie rental industry upside down with its rentals-by-mail model, and is doing it again with streaming digital movies.

Recent Price $212.62


Trailing P/E Ratio 71.8

Return on Equity, Last 12 Months 65.8%


The businessIf you don’t know what Netflix is, I can tell a few things about you:

You don’t watch a whole lot of movies.

You don’t even watch TV or surf the Internet, or else you would not have been able to avoid the torrent of brand advertising for the innovative movie rental service.

You may live under a large rock somewhere in the Utah salt flats.

In the 2000s, Netflix brought the novel idea of shipping movie rentals by mail into a fat and complacent movie rental industry — and turned the whole industry inside out. Now former champ Blockbuster has declared bankruptcy and risks irrelevance, and mom-and-pop video stores are about as common as yeti sightings. And that’s just the beginning.

For an encore, Netflix was first to market with a digital streaming service that delivers movies to computers, Blu-ray boxes, modern TV sets, and even mobile gadgets, all for the low, low price of free with any full-priced DVD-mailing subscription. This subscription model is radically different from the pay-per-rental services you’ll find from Apple (Nasdaq: AAPL) and Amazon.com (Nasdaq: AMZN), and consumers appear to like it a whole lot better. The subscriber growth curve tells that tale better than words.

With more than 15 million paying subscribers, Netflix is already larger than Time Warner Cable (NYSE: TWC), which is the second-largest cable TV network by number of subscribers, and likely to catch No. 1 Comcast (Nasdaq: CMCSA) in the next couple of years.

Why it’s a core stockThe massive subscriber base is the result of a deliberate

strategy to grow customer counts above all else. By pumping any extra cash into more advertising and better digital streaming licenses, growth is nearly guaranteed while earnings and cash flows end up looking small.

But the day will come when there’s no need to push that hard for new subscribers anymore — the customer base will be big enough to move into the next phase. Turn off that investment faucet and the cash will start collecting very quickly in Netflix’s coffers. What now looks like an expensive stock will immediately become a bargain when measured against the new economics. When that happens, you don’t want to sit on the sidelines. And afterward, you will own an established leader in a whole new era of enter-tainment history — and business.

There is also a good chance that a competitor will buy Netflix wholesale before that transformation happens, because we investors are not the only ones who see what’s happening. Apple and Amazon are often mentioned as would-be Netflix owners, and I wouldn’t count Google (Nasdaq: GOOG) or Comcast out of the game, either. Anybody with a fat wallet and serious ambitions in digital entertainment would do well to place a bid, at the very least.

risksJust as Netflix overthrew the old order, the new one is not immune to competition. You will often hear Coinstar (Nasdaq: CSTR) and its Redbox movie rental vending machines mentioned as a serious threat, because low-cost access to hot new releases at the nearest strip mall can trump the higher convenience but less up-to-the-minute collection of Netflix streams.

Likewise, the horde of digital rivals might figure out how to make their rental services stand up to the Netflix challenge eventually, and nobody knows what wizardry could be brewing in Berkeley garages and MIT dorm rooms.

Netflix defends against all of these threats by focusing on doing what it does best: movie rentals by subscription, de-livered in the most convenient format the studios will allow.

In sumThis stock has been on an absolute rampage for a while, and shareholders have more than tripled their money in the last year alone. Meanwhile, the company is expanding its streaming library by investing almost every spare dime in new licenses. That combination makes the stock look tremendously expensive by any metric — but then you’re assuming that the train will keep on rolling down the exact same tracks until the end of time. As we’ve already seen, that’s not in the cards.

You need a rather long investing timeline to hunker down


with Netflix, because the switch to cash-generating digital dominance could still be years away. But when it happens, you definitely want to own this stock.

Disclosure: Fool contributor Anders Bylund holds no posi-tion in any of the companies discussed here. Google is a Motley Fool Inside Value recommendation. Google is a Motley Fool Rule Breakers pick. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. The Fool owns shares of Google.


BHP BillitonbY DavID lee SMITH

Company bHP billiton (NYSE: BHP)

What it does

BHP is the world’s largest miner, with products ranging from aluminum to zinc and worldwide distribution.

recent Price $93.90

Market Cap $261 billion

Trailing P/e ratio 15.3

return on equity TTM 34.4%Source: Yahoo! Finance.

The businessWhether working on a piece for my Foolish friends, or in my earlier days as a Wall Street analyst, I have remained cognizant that it’s a major no-no for analysts to fall in love with the companies they’re examining.

Nevertheless, I must admit to at least a fascination with Australia-based BHP Billiton (NYSE: BHP), the world’s biggest minerals and metals producer that also sports sub-stantial petroleum operations. At the same time, it hasn’t hurt that BHP has kept us entertained with takeover efforts involving the likes of Rio Tinto (NYSE: RTP), its big, London-based mining colleague. More recently, it has been preening for Canada’s PotashCorp (NYSE: POT) with a not-well-received offer of $38.6 billion.

BHP’s current array of products includes base metals such as lead, silver, zinc, copper, gold, and molybdenum. Beyond that, it is a producer of primary aluminum, and its carbon steel materials include manganese alloy, iron ore, and metallurgical coal. It shares iron ore supremacy with Rio and Brazil’s Vale (NYSE: VALE), with the trio control-ling a slug of the world’s supply, much of which ends up in Asian steel mills.

BHP’s other products include energy coal, uranium, and petroleum. In fact, unbeknownst even to most in the energy industry, BHP’s acquisition interests have spread far beyond Rio and PotashCorp. For years, it has discussed making a joint run at Australia’s Woodside Petroleum with Royal Dutch Shell (NYSE: RDS-A). Further, it has appar-ently studied wounded BP’s (NYSE: BP) Gulf of Mexico assets, along with eyeing BP’s Macondo partner Anadarko Petroleum (NYSE: APC).

But lest you think BHP is on its way to becoming an oil company, some of its other product lines seem likely to reduce the importance of hydrocarbons to the company. For instance, a doubling of iron ore production, along with what I consider to be a major movement into potash, would

reduce the overall value of oil and gas to the company.

Why it’s a core stockBHP’s strength results primarily from the variety of its product base. Its iron ore business has grown to the point that it accounts for more of the company’s earnings than any of the other products described above. And while trends come and go, there appears to be little likelihood that this product line will wane in importance in the near term. And while Rio Tinto has suffered bribery and espionage charges in China during the past year, BHP has remained unscathed, and is shipping 100% of its ore production.

In fact, much of the iron ore demand emanates from China’s and India’s huge appetite for steel, of which iron ore is one of the major ingredients. And as BHP CEO Marius Kloppers told a group in London not long ago, China, in particular, is making continuous use of steel in its efforts to develop new urban infrastructures, along with utilities and power systems.

And beyond that, improving demand in North America, Japan, and Europe could place a new floor under the world of commodities prices.

risksPerhaps it’s the economist in me, but when I look carefully at BHP and its peers, the salient risk that I see involves the still-weak economies of the Western countries slipping into another recession — or failing to emerge meaning-fully from the one that we tripped into a couple of years ago. Unfortunately, a daily examination of The Wall Street Journal or a perusal of constantly emerging economic statistics can leave one with diametrically opposed levels of confidence each day.

Clearly, few seers expected the commodity roller coaster that struck us during the past couple of years. On that basis, we have little choice but to stay vigilant and watch develop-ments going forward.

As for BHP, however, my senses tell me that nearly a world-wide economic cataclysm would be required to derail the Melbourne company. And since I don’t envision such an event occurring, I expect the large and diverse company to remain solid.

In sumBHP’s shares haven’t shot the proverbial lights out recently, but neither have they been devastated by the economic events that have been so difficult to tolerate and even to understand of late. But the inkling that BHP’s wide product base can — and likely will — continue to provide a special level of support for the company should now be expanding


for Fools and perhaps less sagacious investors as well.

On that basis, and especially if the world’s economy con-tinues to improve, however slowly, I can’t imagine a better holding than this solid company.

Disclosure: Fool contributor David Lee Smith doesn’t own shares in any of the stocks named.


Lockheed MartinbY rICH SMITH “Blue Chip.” “Nifty 50.” “Rule Maker.”

Over the years, investors have invented many names for the “perfect stock” — the one you can buy, own, and hold for-ever (give or take a week). I want to suggest one more name for your consideration. The real perfect stock, the one that deserves a place in your portfolio today, tomorrow, 10 years from now, and beyond: Lockheed Martin (NYSE: LMT).

Company lockheed Martin (NYSE: LMT)

What it does

Everything President Eisenhower ever warned you about the military-industrial complex — and it does it for a nice profit.

recent Price $80.17


Price-to-earnings ratio 10.1


The businessI can’t tell you all about Lockheed in the word count I’ve been allotted here. Instead, I’ll sketch out just a few key areas of this business, and why they’re bound to keep this company looking attractive and making money for its shareholders well into this century, and beyond.

Broadly speaking, Lockheed consists of four business seg-ments:

Aeronautics: fighter jets, transport aircraft, unmanned aerial vehicles, and the like.

Electronic Systems: primarily systems in support of mili-tary equipment.

Information Systems & Global Solutions (IS&GS): a catch-all ranging from government IT contracting to pro-grams supporting troops abroad.

Space Systems: satellites, strategic missile defense, and space exploration.

The first three businesses contribute roughly equal percent-ages of Lockheed’s revenues, with space systems trailing behind at about a 20% share of the business. Profits-wise, aeronautics and electronic systems are the most profitable units, contributing about 35% of pre-tax profit apiece. IS&GS and space make up the balance.

Why it’s a core stockBut as I say, this is just a broad outline. Like most defense

contractors these days, Lockheed is constantly evolving, shifting emphasis from one business segment to another, spinning off “non-core” businesses and dipping its toes into the water on new opportunities, such as the recent announcement that Lockheed will participate in a seven-year, $2.8 billion project to update the Social Security Administration’s computer systems, or last year’s contract to create a surveillance camera system for the New York subway system.

To me, though, it’s the core of Lockheed’s busi-ness — fighter jets — that makes this company a core stock for any investor’s portfolio. When Lockheed and its team of subcontractors, including Northrop Grumman (NYSE: NOC), General Electric (NYSE: GE), and United Technologies (NYSE: UTX), beat out a rival team led by Boeing (NYSE: BA) in the contest to build the Pentagon’s F-35 Lightning II fighter jet a few years ago, Lockheed did more than win a contract. It won the contract to build what U.S. Joint Chiefs Chairman Adm. Michael Mullen predicts will be “the last manned fighter” jet ever to be built.

It’s hard to overstate just how important the F-35 is to Lockheed, and to investors looking for a stock to own for the long term. Defense industry pundits believe F-35s will still be flying 60 years from now, and will generate roughly $1 trillion in sales for Lockheed domestically. But that’s just the beginning. F-35 is an international effort, with foreign partners expected to buy roughly one-third of all the planes Lockheed will build over the next six decades. Add these sales to the mix, and F-35 becomes potentially a $1.3 trillion project.

To put this in perspective, F-35 alone has the potential to secure half of Lockheed’s annual revenues over the next 60 years. Suffice it to say I have every confidence the other planes that Lockheed’s aerospace unit builds, combined with the multitudinous products from electronics, IS&GS, and space, will have little trouble filling out the remaining half.

risksThere is, of course, a risk to the stock, in the form of defense spending cuts. For the past several months, Secretary of Defense Robert Gates has been running ‘round the Pentagon halls, waving a hatchet and looking for programs to cut. Already, high-profile projects led by Raytheon (NYSE: RTN), SAIC (NYSE: SAI), Boeing, and others have fallen victim to Gates’ budgetary ax.

But for a long-term investor, fears of a short-term falloff in military spending spell opportunity. Opportunity in the form of a company expected to grow its profits north of 8% per year over the next five years, bolster those returns


with a 3.7% annual dividend, yet cost you a mere 10.1 times earnings to own.

In sumIf you’re looking for a company to own for the long term, a business that’s practically guaranteed to be selling its product for the next 60 years has to sound attractive. When that business is selling for a discount, that only adds to the attraction. To my Foolish eye, there’s only one company in the world that meets both these criteria: Lockheed Martin.

Disclosure: Fool contributor Rich Smith has no position in any of the stocks named above. SAIC is a Motley Fool Inside Value recommendation.


those nice annual raises.

McDonald’s has proven it’s an all-weather holding over the recent stock market roller coaster ride. Using the SPDR S&P 500 (NYSE: SPY) ETF as a benchmark for the stock market, here’s how McDonald’s stacks up with both securi-ties adjusted for dividends over the past three years.

Metric SPY Change MCD Change

Market High 147.07 51.23

Market Low 66.57 -54.74% 48.39 -5.54%

Recent Price 112.49 68.98% 74.32 53.59%*Source: Yahoo! Finance and author’s calculation.

McDonald’s shareholders saw only a little of the market’s slide from the highs of late 2007 through the lows of March 2009, but still captured much of the upside since the lows.

In addition to smoothing out the Mr. Market’s wild ride, McDonald’s adds stability with a truly global business model. The company generates well over half its revenue from outside the U.S. I’m not smart enough to know which of the world’s economies will be the strongest over the next few years, but I do know McDonald’s will be there.

Why McDonald’s? There are a number of companies that meet the two criteria listed. Procter & Gamble (NYSE: PG) and its global consumer products business and long dividend history, fellow fast-food operator Yum! Brands (NYSE: YUM) and its great opportunities for growth in China, and global soft drink powerhouse Coca-Cola (NYSE: KO) all jump to mind as great core stock candidates.

McDonald’s edges ahead of the pack with the way it has used its menu to drive revenue. It pushed the low-cost Dollar Menu to draw consumers when the economy looked weakest and has added higher-priced, higher-margin pre-mium products to keep those value customers coming back and bring in new customers to try smoothies, coffee drinks, and premium burgers.

risksLike any stock, an investment in McDonald’s carries some risks.

Governments occasionally talk about regulating or taxing the unhealthy menus common at fast-food restaurants.

Commodity cost increases are outside McDonald’s control. There is no guarantee the company will be able to pass cost increases along to consumers.

New product rollouts often have to go head-to-head with established players like Starbucks (Nasdaq: SBUX) coffee or Jamba (Nasdaq: JMBA) smoothies.

McDonald’s bY ruSS krull Many of the people reading this had a cup of coffee, ate a meal, tried a smoothie, or grabbed a snack at McDonald’s (NYSE: MCD) today. At the pace reported last quarter, to-day’s sales at the Golden Arches will total over $65 million across the globe.

Company McDonald’s (NYSE: MCD)

What it does

McDonald’s operates or fran-chises over 32,000 fast-food restaurants around the world.

recent price $74.47


forward P/e 13.5


Source: Yahoo! Finance and Capital IQ.

The businessMcDonald’s has more than 32,000 restaurants around the world, with about 26,000 franchised and the rest company-owned. Franchised restaurants contribute rent and royalties to McDonald’s revenue.

The menu includes burgers, other sandwiches, fries, break-fast items, and a variety of drinks with many items on the value-oriented Dollar Menu. Recently, the menu has been expanded to include coffee drinks, smoothies, and Angus burgers to add higher-priced and higher-margin items.

Why it’s a core stockA core holding should have two key characteristics.

• A reasonable dividend yield with a track record of increasing the payout and good prospects for con-tinuing those raises.

• A business model that works in any economic envi-ronment.

Others may have different investment needs and use dif-ferent criteria to define a core stock, but those are mine and together they add up to a stock with a potential holding period of forever. So how does McDonald’s stack up?

At the current price and dividend rate, McDonald’s yields a little over 3.2%, well above the yield on a 10-year Treasury. In fact, it just announced a sizable bump in its payout. The company has increased the dividend every year since 1976, the year it first paid one. With a payout ratio — the portion of earnings paid as dividends — of less than 50% and projections of continued revenue and earnings growth, McDonald’s has the ability to continue giving shareholders


The stock has recently been setting all-time highs and is priced at a premium to the market. I believe the premium valuation is justified, but the company needs to continue executing well to maintain that valuation. A recent monthly sales report spooked investors expecting better numbers and resulted in a one-day drop of more than 2%.

In sumNo stock is risk-free or perfect for every investor, but McDonald’s offers investors a good income stream that’s likely to keep growing, some protection against market downturns, and good prospects to capture a big bite of bull market gains. That makes it an ideal core stock pick for many investors and those are some of the reasons that my Foolish colleague Jim Royal has called the stock a dividend play for a lifetime.

Disclosure: Fool contributor Russ Krull owns shares of McDonald’s, but no other companies mentioned. Coca-Cola is a Motley Fool Inside Value selection. Starbucks is a Motley Fool Stock Advisor pick. Coca-Cola and Procter & Gamble are Motley Fool Income Investor recommenda-tions. The Fool owns shares of and has written covered calls on Procter & Gamble. Motley Fool Options has recommended a bull call spread position on Yum! Brands. The Fool owns shares of Coca-Cola and Yum! Brands.


consumer brands.

This is important because that means Johnson & Johnson has to keep up its research and development pipelines and/or acquire replacement businesses to replenish patent expiries and keep growth going. This is in contrast to purer consumer goods plays like Kimberly Clark (NYSE: KMB) or Procter & Gamble (NYSE: PG) that rely on maintaining their time-tested brands.

In the last 12 months, J&J has continued its long-standing practice of making acquisitions and spent $7 billion on R&D — over 10% of sales. As a percentage of sales, this is less than pharmas Merck (NYSE: MRK) and Eli Lilly (NYSE: LLY) but more than medical device-makers Stryker (NYSE: SYK) and Becton Dickinson (NYSE: BDX).

Why it’s a core stockThere are only a handful of companies left that have the top AAA rating on their debt. Johnson & Johnson is one of them. That’s a nod both to its conservative capital structure (it had more cash than debt as of its last quarterly filings) and to its ability to generate cash flows to cover its obliga-tions (it converts over 20% of its sales into free cash flow).

J&J’s stable of recognized brands and patents form a strong moat to protect its business. To give you an idea of how strong its business is, Johnson & Johnson ranks No. 1 or No. 2 for 70% of its products. And its practice of decentralizing its operations ensures that the behemoth can stay nimble and entrepreneurial to refill the moat.

risksNear-term, Johnson & Johnson has had trouble with nu-merous recalls on its products. If handled improperly, this kind of bad press can seriously hurt its brands. In addition, there is related litigation risk.

Longer-term, as I talked about earlier, J&J must be efficient in replenishing its drug and medical device pipelines as patents expire.

In sumJohnson & Johnson is a robust global health care play that is trading for around 11 times trailing free cash flow and is throwing off a 3.5% dividend yield. At current prices, I believe Johnson & Johnson is a solid addition to your portfolio’s core. And I’m not the only one. It’s recently been picked in our 50 Stocks in 50 Days series, Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B) has been loading up on the shares, and our CAPS community gives it the maximum 5 stars.

Disclosure: Anand Chokkavelu owns shares of Berkshire

Johnson & JohnsonbY ananD CHokkavelu, Cfa You probably know Johnson & Johnson (NYSE: JNJ) because of products like Tylenol, Band-Aids, and Johnson’s Baby Shampoo.

But if you think those brands are why I’m choosing Johnson & Johnson as one of our 10 core stocks, you’re only 15% correct.

That’s how much consumer brands like the three above contribute to Johnson & Johnson’s profits.

Company Johnson & Johnson (NYSE: JNJ)

What it does

J&J is a major player all over the health-care space, from consumer products to prescription drugs to medical devices.

recent Price $59.64


Trailing P/e ratio 12.5



The businessIt’s popular to call Johnson & Johnson a health-care mutual fund. This is a fair characterization. It has more than 250 business units located in 60 countries throughout the world. These 250-plus business units contribute to three main lines of business. Here’s a summary:

Line % of Sales

% of Prof-its* Key Brands

Consumer 26% 15%

Tylenol, Band-Aid, Johnson’s Baby, Stayfree, Neutrogena, Sudafed

Pharma-ceuticals 36% 39%

Remicade (inflamma-tory disorders), Procrit (red blood cell booster), Levaquin (anti-infective), Risperdal Consta (schizo-phrenia)

Medical Devices 38% 46%

Cordis (heart), DePuy (joint reconstruction, spine), Ethicon (surgical care)

Source: Capital IQ, a division of Standard and Poor’s. *Segment information uses operating profits before taxes.

A couple things to note: (1) I could have kept going ... and going ... on the brands. J&J is rife with them. (2) Notice that medical devices and pharmaceuticals drive much more profits (and higher margins) than the more famous


Hathaway. Becton Dickinson , Berkshire Hathaway, and Stryker are Motley Fool Inside Value recommendations. Berkshire Hathaway is a Motley Fool Stock Advisor pick. Johnson & Johnson, Kimberly Clark, and Procter & Gamble are Motley Fool Income Investor selections. The Fool owns shares of and has written covered calls on Procter & Gamble. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Berkshire Hathaway and Johnson & Johnson.


When it comes to ETF investing, there are two simple keys to success — keep it cheap and keep it broad. I recommend folks stay away from narrowly focused, specialized funds that only invest in one particular industry or country, espe-cially if they are leveraged or inverse leveraged funds.

Specialty funds like these are not only more risky than most investors need for their portfolio, but they typically come with higher price tags — in some cases, even higher than most actively managed mutual funds. That’s why inves-tors should stick to the ETF basics. Vanguard Total Stock Market meets the criteria for broad and cheap in spades.

If you’re looking for inexpensive, wide-market coverage, you won’t do much better than this fund. Vanguard Total Stock Market ETF clocks in with a rock-bottom 0.07% ex-pense ratio, the cheapest exchange-traded fund in existence, with only one exception. Another popular broad-market ETF, the SPDR S&P 500 ETF (NYSE: SPY), sports a 0.09% annual price of admission, which isn’t a whole lot more than the Vanguard fund, but over time even small fees can add up and eat away at your returns.

The fund invests across the market capitalization spectrum, but as can be expected for a market-cap-weighted index, big-name blue chips tend to take the spotlight. Splashier growth name Apple (Nasdaq: AAPL) and value-priced Microsoft (Nasdaq: MSFT) from the tech arena stand alongside more staid consumer and health-care stocks such as Procter & Gamble (NYSE: PG) and Johnson & Johnson (NYSE: JNJ) to provide balanced exposure to the entire stock market. Midsized and small-cap names account for roughly 20% and 6% of assets, respectively.

risksThe biggest risk involved in owning Vanguard Total Market Stock ETF is market risk. Because the fund contains thousands of names, individual blowups won’t affect the portfolio. But macroeconomic conditions and the general market environment will be both the primary drivers and risk factors here. If another market meltdown happens, this fund won’t protect you from that carnage.

And while this isn’t a risk inherent in owning the fund itself, I think it warrants mentioning that while the fund attempts to capture a wide swath of the domestic stock market, it does emphasize large- and mega-cap stocks rather heavily. So unless you own a handful of individual small-cap stocks elsewhere in your portfolio, you might want to also stock up on another ETF that invests exclusively in small-fry com-panies, like the Vanguard Small-Cap ETF (NYSE: VB).

In sum

Bonus: The Core ETF You Need to OwnbY aManDa b. kISH, CfaWhile individual stock pickers may enjoy the process of researching and monitoring several dozen companies, that approach isn’t for everyone. For investors who want to save some time and get wide exposure to the stock market in one shot, a low-cost exchange-traded fund (ETF) is the way to go. Even stock pickers can benefit from adding a core ETF to their holdings, which will instantly diversify and broaden any portfolio.

The businessVanguard Total Stock Market ETF (NYSE: VTI) is hands-down one of the best core exchange-traded funds for virtually any investor. The fund tracks the MSCI U.S. Broad Market Index, which consists of all domestic stocks on the NYSE and Nasdaq markets. The fund typically holds between 1,200 and 1,300 of the stocks in the target index. You won’t leave the market in your dust with this fund, but you will get well-diversified exposure for a next-to-nothing price tag.

Metric vanguard Total Market Stock eTf

fund objective

The fund employs a passive management strategy to track the MSCI U.S. Broad Mar-ket Index, which consists of all common U.S. stocks traded on the New York Stock Exchange and Nasdaq over-the-counter market.

recent price $68.34P/e ratio 8.5

Source: Google Finance.

Since its June 2001 inception, this fund has posted an an-nualized 1% return through the end of 2010, compared to a completely flat showing for the S&P 500 index. That isn’t a huge difference, but for a passively managed investment that’s not aiming to beat that market, that’s not too shabby! Turnover is a low 5% here, so the fund can be utilized in both tax-advantaged and taxable accounts without worrying about excessive capital gains.

Vanguard Total Stock Market ETF is a well-rounded fund option that is suitable for investors of all stripes. That’s why we recommend the fund in all of the model portfolios we’ve created in the Fool’s Rule Your Retirement invest-ment service. From the youngest, most aggressive investor to gun-shy retirees who shun unnecessary risk, this fund has something for everyone, thanks to its broad mandate.

Why it’s a core eTf


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While you can’t build a diversified portfolio with just one stock, you can come pretty close to accomplishing that task with just one exchange-traded fund. The Vanguard Total Stock Market ETF is an ideal core holding for any portfolio, thanks to its broad market coverage and low expenses. If you buy just one ETF this year, make it this one.

Disclosure: Amanda Kish is the Fool’s resident fund ad-visor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Apple is a Motley Fool Stock Advisor choice. Microsoft is a Motley Fool Inside Value recommendation. Johnson & Johnson and Procter & Gamble are Motley Fool Income Investor choices. Motley Fool Options has recommended diagonal call positions on Microsoft and Johnson & Johnson. The Fool owns shares of and has written covered calls on Procter & Gamble. The Fool owns shares of Microsoft.

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10 Core Stocks

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