500’s stocks have traded between nine and 20 times corporate earnings, the average figure being about 14-15, a sign that the stocks that make up the index might be a bit expensive and that share prices might be deemed too costly. Under that scenario, it’s best to look for stocks that trade at a lesser multiple.
Stocks are also priced based on predictions of earnings growth, or the average percentage that analysts feel profits or net income will increase. A high growth rate portends good things to come. As earnings increase, more investors will be lured to buy company shares, which in turn will boost the stock price. A rise in profits generates more cash for a company to reinvest in operations, which in turn help fuel even higher earnings. A composite estimate compiled by Zacks shows analysts feel the S&P 500 is due for something of a slowdown the next five years, with average annual growth tapering off to the 6.7% range, down from a 12.6% clip the last few years.
There are other statistics that interested us as well. In some cases, we calculated stock’s yield by dividing a company’s dividend by its share price. Dividends, which are quarterly income payments companies make to shareholders, are a tonic that many money managers seek out for a number of reasons. For one, management that grows dividends successfully is essentially telling the market that business is good and that shareholders deserve a prize for sticking with the company. Secondly, if the stock market, for some reason, neglects a certain company, and shareholders don’t see a great appreciation in the price of the stock they own, a dividend serves as compensation for their investment until share prices rise. Finally, we checked on return on equity, a stat that is derived by dividing a company’s annual income by stockholder’s equity. If that sounds confusing, think of it this way: ROE, as it’s known, measures how much management made with the funds it raised from investors, an indication of just how efficient the folks at headquarters are. Currently, the average ROE for the S&P 500 is 19%, so we looked for companies that comfortably exceeded that.
CASTING OUR NETS
the market’s vital signs, it’s time to devise and run our screens on the 6,063 stocks listed in the Zacks software. A first consideration is company size, as indicated by market capitalization, a statistic easily calculated by multiplying a corporation’s stock price by the number of shares it has outstanding. Since our aim is to home in on five core holdings, it’s important to aim for companies with a large market cap of at least $300 million, a girth or wherewithal that acts as ballast when economic or industry tides turn. Another thing we looked for in each screen is low leverage as measured by a company’s debt-to- capital ratio. Let’s face it, any breadwinner knows that carrying a four- or five-figure credit card balance is going to saddle your budget with interest payments high enough