Motley Fool: Moats give stability to portfolio

Here’s a litmus test for stocks, via Warren Buffett: Say you knew that the day after you bought a stock, the market would close for five years, so no matter what happens, you’re stuck. Would you still invest?

The best companies have sustainable competitive advantages – or moats. Consider Procter & Gamble, with its dividend yield recently at 3.2 percent. Its success stems from its portfolio of strong brand names (think Tide, Crest, Pampers) and its cost advantages, such as being able to inexpensively produce new varieties of best-sellers.

Here are a few more:

• Diageo, recently yielding 3.1 percent, sports a massive brand portfolio including Jose Cuervo, Smirnoff and Guinness.

• Johnson & Johnson recently yielded 3.6 percent, with brand names such as Tylenol and Band-Aid, a collection of pharmaceutical and medical device patents, and a robust research pipeline.

• Philip Morris International, recently yielding 4.1 percent, owns seven of the top-selling international cigarette brands, including Marlboro.

• PepsiCo, with a recent yield of 3.2 percent, dominates the salty snack category with its Frito-Lay collection of brands. Its direct-to-store delivery system keeps competitors off the shelves, too.

Any of these massive-moat dividends would make a solid addition to your portfolio. (The Motley Fool’s newsletter services have recommended shares or options on all five companies.)

Ask the Fool

Q: What are LEAPs? – H.H., Decatur, Ill.

A: They’re long-term options, ones that expire after more than a year from their issue date.

Standard options let you purchase the right to buy (via “call” options) or sell (via “put” options) a fixed number of shares of a stock at a fixed price within a fixed time period, typically a few months.

Here’s an example: If you think that Tattoo Advertising Co. (Ticker: YOWCH), trading at $40 today, will soon be at $60, you might buy call options for $6 per share that let you buy the shares at $45. That will ultimately cost you $51 per share, netting you a $9 profit – but only if the stock hits your target before the expiration date. Options such as these often end up expiring worthless.

That’s why LEAPs, with their longer time frames, can be more attractive, despite costing more. They give the underlying stock more time to move.

Options are not for beginning investors, and many successful and experienced investors steer clear, too. Still, used sensibly, they can make you money. Learn more at www.cboe.com/LearnCenter and www.fool.com/investing/ options/options-a-foolish- introduction.aspx.

Q: What’s the “efficient market theory”? – C.S., Monticello, Minn.

A: It suggests that all available information about a stock is known and factored into its price. Thus, an investor shouldn’t be able to find undervalued or overvalued stocks.

There are strong and weak forms of this theory, and it’s not embraced by all. We Fools tend to see the market as generally efficient, but there are still occasional inefficiencies that alert investors can take advantage of. A well-regarded book on the topic is Burton Malkiel’s “A Random Walk Down Wall Street” (W.W. Norton, $30).

My dumbest investment

I read an article years ago, saying that LED light fixtures provide significant energy savings over compact fluorescent bulbs, with a nice white spectrum. With a minimum of research, I dropped $700 on Cree, a dominant player in the technology, and ended up losing money. – Chris, London

The Fool responds: A compelling product is rarely enough. LED bulbs are indeed very efficient, requiring relatively little power to put out strong light. But for now, they remain rather costly, and that’s keeping many people from buying them, even if the long-term economic argument makes sense. Such bulbs are selling for around $20 to $30 apiece these days. That doesn’t mean they’re doomed, though. As long as their manufacturers have staying power, as demand grows and production scales up, costs will come down.

But as with any investment, you need to be sure the company is healthy, well-managed and in a good competitive position. You don’t want it to run out of money or have a rival eat its lunch. Cree has other lines of business, too, such as LED chips for video screens and gaming displays.