A stock market report card

The Ford Foundation's Lew: return on equity tells you if management is making the grade

The fickle fortunes of technology companies are enough to confound even the most patient shareholders. One minute a technological breakthrough is making investors rich; the next day the same stock smolders in ruins.

One way to tell if a high-flying tech company is set to soar even higher or is headed for a crash landing is to look at its return on equity, or ROE, says Ford Foundation analyst and portfolio strategist Kim Lew. Lew, who has picked stocks in industries ranging from semiconductors to software, says she particularly likes companies with rising ROEs. “That means management is investing in technologies or production methods that are increasing earnings-a signal that there’s a nice growth spurt ahead,” she says.

Generally speaking, market participants like to see ROEs that hover around 20%. However, Lew prefers stocks with increasing ROEs-including those of companies that have slumped and now are on the rise-which she says are “a good indication that a stock is probably on its way up.”

Overall, Lew thinks software companies and corporations with a stake in the Internet are set to prosper in the year ahead. “You want to angle towards a company with a defensible strategy for the Net, or perhaps a firm that has figured out a unique angle to e-commerce.”

One of Lew’s picks that has staked out a niche on the Net is Intuit (Nasdaq: INTU), which provides financial software packages such as Quicken and Turbotax. Quicken’s Website has quickly become an Internet success, says Lew. Meanwhile, Turbotax has staked out a dominant share of the tax-preparation software sector, she says. Intuit is now seeing its return on equity rise to 2%, says Lew and expected to show considerable gains in 1999.

Lew calls telecommunications and computer networking equipment maker Lucent Technologies (NYSE: LU) “one of the few companies that actually makes money on the Internet.” The company’s wares are in hot demand by telephone companies and Fortune 500 firms that want improved communications networks and links to the Web. Another plus is Lucent’s robust ROE. It’s 45%, and likely to rise.

And since Lew feels it would be a shame not to have a stake in a “real” Internet firm, she recommends America Online (NYSE: AOL). A P/E ratio of 400 might make the stock a bit hard to stomach, but Lew points to two figures that bode well for AOL shareholders. The first is a ROE of 51%. The second is over 50% annual earnings growth rate.

Other standouts from a ROE perspective include tech stock staple Microsoft (Nasdaq: MSFT), with a 39% ROE, and Texas Instruments (NYSE: TXN), with a more modest 12% ROE, but one that’s likely to climb, Lew says.

Company

Exchange: Symbol

Price *

Est. 5-Yr. Annual EPS Growth

P/E

Why Stock Will Outperform

America Online NYSE: AOL $113.13 51.6% 401.4 With its acquisition of Netscape and alliance with Sun Microsystems, AOL is becoming e-commerce’s

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