Reaching beyond Intuition: What Are the Experts Doing?

You can quickly and easily find out what the investment experts are doing by simply watching what mutual funds managers are investing in. For example, you may have heard or read about the huge increase in Internet stock prices. You may have read that some analysts believe that much of this activity is sheer speculation. You can watch mutual funds that invest in Internet stocks and see how they performed. How do you find out about a mutual fund’s performance? You request the fund’s prospectus from a broker or mutual fund Web site. A prospectus is a detailed overview of the investments in a mutual fund, written according to government guidelines. After you have the prospectus of a fund you’re interested in, look at the stocks the fund managers are investing in and how successful they’ve been. For more detailed information about mutual funds, pick up a copy of CliffsNotes Investing in Mutual Funds.

How do you find a list of mutual funds? In the financial pages of The Wall Street Journal, The New York Times, and Investor’s Business Daily, as well in many other sources like local newspapers and Web sites, you can find lists of mutual funds and their current performance. Prospectuses are free and available by contacting mutual fund companies by a toll-free call or looking for the mutual fund online.

After you read the prospectuses of several mutual funds, narrow down your choices to at least 5 to 10 mutual funds that invest in stocks you’re interested in. Study how the stocks have performed and use this as a guide to how the experts invest in the stock market. In addition to reading mutual fund prospectuses, you can also read up on what the experts are saying. As you browse the papers and periodicals in your local library, be sure to take at least a passing glance at analysts’ columns. Often, this kind of commentary mentions individual stocks or classes of stocks that are on the way up or down. Make a list of at least some of these stocks and do some research.

Picking Stocks: Some Criteria

As a new investor in the stock market, base your investment strategy on long-term increases in stock value. Follow the first rule of stock purchasing: Buy stocks that are good values at the time of purchase and that promise above-average growth for the foreseeable future. Close observation of a company’s fundamentals can help you identify stocks of good value. In brief, fundamentals are the key indicators of the financial health of the company. The fundamentals can help provide you with an accurate picture of how much the company is earning, whether these earnings are a solid return on the money investors have put into the company, and whether the company seems able to maintain a steady, upward trend of solid earnings. Some aspects of a company’s fundamentals to pay attention to include:

- The company’s quarterly and annual performance

- The company’s management team and style

- The company interest and financial commitment to researching and developing new products Value Line and Standard and Poor’s Stock Reports provide some very useful narrative information about company fundamentals, in addition to offering lots of statistical data. You can add to my preceding list of fundamentals as appropriate. Each additional bit of data can add some new insight into a stock’s underlying value. A word of caution extended analyses, however, can require you to spend a lot of time gathering data and cause burnout paralysis by analysis.

My recommendation is that you focus on eight readily available and easily understood measures or criteria of a company’s fundamental value. The goal of going through the same eight criteria for each company is to answer the question: Is this is a good company for me to invest in for the long run? As you research, look at the following specific eight criteria: You may be concerned that researching all the following fundamentals will take hours of your time. Don’t worry. In almost all cases, the work has already been done for you. The complete stock reports that you find in The Wall Street Journal and Investor’s Business Daily report much of the following information every day. (For sales and earnings history, you do have to go to your public library and check Value Line or the S&P Reports.) And don’t forget to check Web sites on the Internet. They contain a gold mine of information! See the Web sites listed in the Resource Center in the back of this article.

1: EPS: Earnings per share

The first bit of information you need to know about a company is how much money it is making. For ease of comparison among companies, earnings are universally expressed as earnings per share (EPS). These earnings are what’s left from gross revenues after expenses, taxes, bad debts, and so on have been subtracted. For publicly traded and listed companies, these earnings and other financial data come from audited financial records approved by a Certified Public Accounting firm.

2: P/E ratio

The P/E ratio shows the relationship between the stock’s current price and its reported annual earnings.

A P/E ratio of 20 means that a company earns five cents for every $1.00 you invest. This does not mean that the company pays a dividend of five cents per share. The company may pay no dividend at all. The P/E ratio tells us how much you have to pay to buy those earnings per share. In the past, P/E ratios hovered between 10 and 20, but with the surge in stock prices in the 1990s, P/E ratios in the 40 to 60 range and higher are increasingly common. Generally, the lower the P/E ratio, the more preferable the stock. Profit, another name for earnings, is what drives the price of stocks and payment of dividends.

3: ROE: Return on stockholders’ equity

The ROE, or return on equity, looks at the company’s profitability from a different point of view. This figure tells you what the company has done in the past with the money that stockholders have invested in it. An ROE of 15% or better is very good and maybe even outstanding, depending on the industry. If you discover in your research that one company’s ROE is above 15% and another similar company’s ROE is 5%, the company with the higher ROE is clearly the better choice. For a balanced perspective, look at the trends for three or more years.

4: Beta

Beta is a measure of how volatile a stock’s price is relative to the stock market as a whole. A beta of 1 means that the stock moves up and down exactly at the same pace as the market as a whole. A beta greater than 1 indicates that a stock goes up or down faster than the market as a whole. A beta of less than 1 means that the stock’s up or down moves are smaller than the market as a whole. Generally, it is a good idea to avoid stocks with betas above 1 because these stocks are more volatile and more risky.

5 and 6: 5-year sales and earnings history

The 5-year sales and earnings histories each tell you something different. For any stock that you buy, you want to see sales and earnings rise together, with earnings moving upward a bit faster. Earnings that outpace sales usually indicate that the company is becoming more efficient in holding its costs down and in expanding its market.

7: Company size

Why is company size important? Generally, if you’re looking for maximum appreciation in stock values over time, you want to check out smaller companies where the potential for rapid growth is greater than large established companies (such as those companies included in the Dow Jones Industrial Average). Older, larger companies tend to be less nimble and become top-heavy with bureaucracy. The best bets for stronger long-term growth are among the smaller companies, typically those under $200 million in market capitalization.

8: Relative industry strength

You want to look at companies that are ranked at least in the top 25% of their industries preferably higher. You can find information on relative industry strength in Value Line and Investor’s Business Daily. The analyses in these publications are excellent and are not done by people trying to sell you stocks.