Invest Like the Big Guys

Profit in the stock market with a do-it-yourself approach

Burman looks for companies whose sales and earnings have more than doubled in the past five years.

Burman gleans information from www.quicken.com and Better Investing, the magazine published by the National Association of Investors Corp. (www.better-investing.org). “I like growing companies with relatively low price-to-earnings ratios,” he says. “Stock splits also appeal to me, because they bring the stock’s price down into the reach of more investors.”

From there Burman exercises patience before investing. “When I see a stock I like, I keep a close watch on it,” he says. “I saw Compaq Computer fall from over $50 to under $20 in 1999, but I still liked the company. So I bought it and now it’s up to $28.” (For stock quotes that are updated regularly, see blackenterprise.com.)

Moreover, Burman says he considers local companies he likes as possible investments. “That includes Cullen/Frost Bankers Inc. (NYSE: CFR), which survived the savings and loan shakeout; Luby’s (NYSE: LUB), a cafeteria chain that’s a step up from fast food; and Taco Cabana (Nasdaq: TACO), a franchise ready to cash in on the popularity of Tex-Mex food.”

Burman’s focus on sales and earnings growth is echoed by William Fries, manager of Thornburg Value Fund, a five-star Morningstar fund with a three-year annualized return of 31%, which places it in the top 4% of all mutual funds. “Revenue grow
th is particularly important,” he says, “because that indicates whether there’s a demand for the company’s products or services.”

AND ON THE FLIP SIDE . . . VALUE
Fries, who considers himself a value manager, says he watches these basic indicators closely:

  • Price-to-earnings (P/E) ratio. This is the multiple of earnings at which a stock sells. It is determined by dividing the current stock price by current earnings-per-share. A company that earns $2 per share, for example, and sells for $20 has a P/E ratio of 10. Higher ratios mean investors have high expectations for future growth and have pushed up the price.
  • Price-to-cash flow ratio. A similar ratio that compares a company’s stock price to the amount of cash the business generates.
  • Price-to-book value. This ratio compares the stock price to a company’s book value, the value of a company’s total assets minus intangibles and liabilities. A company with a book value of $5 per share and a stock price of $15 has a price-to-book ratio of 3:1.
  • Dividend yield. The company’s latest dividend, annualized, as a percentage of the stock price. Suppose a company with a $40 stock price declares a quarterly dividend of 15 cents. Annualized, that’s 60 cents per year, or 1.5% of the $40 trading price.

Of these ratios, price-to-book is the one preferred by Charles Smith, chief investment officer of Fort Pitt Capital Group, Pittsburgh. “I like to see a company with a low price-to-book ratio and a high and rising return-on-equity,” he says. Return-on-equity, or ROE, is essentially a company’s net income as a percentage of shareholders’ equity. “Today,” says Smith, “the average company has a price-to-book ratio of around 4:1 and an ROE of 17%.” Among his current favorites is Tollgrade Communications

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