Motley Fool: Brewing Profits

Constellation Brands (NYSE: STZ) has seen its stock drop more than 40% over the past year – pushing its dividend yield up to 3.1%. For long-term investors, this is an opportunity to invest in a top beer stock at a big discount.

Constellation holds the U.S. distribution rights to market and sell top Mexican beer brands, including Modelo and Corona. (Its Corona Sunbrew has quickly become the No. 1 new beer brand in the U.S.) Last year, the company’s beer sales totaled $8.54 billion, with sales of wine and spirits totaling $1.45 billion.

The stock is down as consumers have pulled back on discretionary spending, and that has pressured sales of alcoholic beverages. Constellation’s revenue was down 15% year over year in its quarter ending in August, and the company is projecting adjusted net revenue for the full fiscal year to be down between 4% and 6%.

While the company’s sales are dependent on consumer spending trends, people are not likely to stop drinking beer and wine over the long term, and Constellation’s brands rank toward the top of their categories in market share.

Even Warren Buffett and his investing team at Berkshire Hathaway see value here, as they have accumulated 7.5% of the company. Shares look attractively priced for long-term believers at a recent forward-looking price-to-earnings (P/E) ratio of 12. (The Motley Fool recommends Constellation Brands.)

Ask the fool

Q. What’s the “rule of 40” in the investing world? – K.L., Sun City West, Arizona

A. It’s a way to assess the attractiveness of a softwareas-a-service (SaaS) company. To use the rule, you add the revenue growth rate to the profit margin, and if the total is 40 or more, you have a satisfactory result. A big score like that suggests that the company is successfully balancing growth and profitability.

There are multiple “profit margin” measures that can be used in this calculation. A commonly used one is the EBITDA (earnings before interest, taxes, depreciation and amortization) margin: dividing EBITDA by total revenue. Another is the FCF (free cash flow) margin: dividing free cash flow by total revenue.

Remember that the Rule of 40 is a rough measure, and a score of 40 or more should never be all you base an investment decision on. Poor investment candidates could get a good score by growing at breakneck speed while burning through most of their revenue or by having a 50% profit margin while revenue shrinks by 10%.

Q. Can you explain what the “Buffett indicator” is? – H.W., Manchester, Connecticut

A. Named for Warren Buffett, who discussed a version of it back in 2001, it offers a rough assessment of how undervalued or overvalued the stock market is. It’s commonly calculated by taking the total value of all publicly traded U.S. companies and dividing that by U.S. gross domestic product (GDP). Buffett has suggested that a result of 70% or 80% would be enticing, and that at 200% or more, investors would be “playing with fire.” The Buffett indicator has recently been well above 200%.

My smartest investment

My smartest financial move was deciding not to invest – and instead to pay off my mortgage. Around the time of the dot-com bubble in late 1999, I decided to aggressively pay off a 30-year home loan. Each month, my wife and I would pay at least $1,000 extra toward the principal balance. I timed it so that we paid it off on my 50th birthday. We had taken out the loan in 1995 and managed to make the last payment in 2008, saving 17 years of (steadily decreasing) interest payments. So glad I made that decision way back then. – M.G., via email

The Fool Responds: Many people strive to be mortgage-free before they retire, and it looks like you achieved that – and possibly saved more than $200,000 in interest payments, too.

It’s not always an easy decision, though, between making extra loan repayments or investing in stocks. A typical mortgage rate in 1995 was 7.75%, so any extra repayment would be like earning a 7.75% return on that money. Meanwhile, the longterm average annual gain for the stock market is close to 10%, though that’s never guaranteed. So your choice then was between a sure-thing 7.75% return or a potential 10% return. You chose well. It’s less clear when your mortgage rate is, say, 3%.

(Do you have a smart or regrettable investment move to share with us? Email it to TMFShare@fool.com.)