|
Like a roller coaster ride, the stock market always is scariest at the top. The coaster may crank and grind on its way to the pinnacle, but the ride down is one quick whoosh. Not all bull markets end vertically, of course. Some just flatten out like an EKG after the patient has gone night-night. Nevertheless, it is fear that the long, strong bull market of the '90s may be over that causes so much volatility at current prices. Any bad news, like a revolution in Indonesia, a recession in Japan or even a rumor that the Federal Reserve may tweak interest rates up, causes a bounce. So far, the healthy economy here in the United States has helped stabilize domestic investment markets.
Even so, prudent stock investors should now review their portfolios and take steps to protect themselves. On a cheerier note, investors also should get ready to build a great portfolio of bargain stocks, should the crash come.
Geraldine Weiss, publisher of the Investment Quality Trends newsletter in La Jolla, warns that investors should act immediately. "According to the highly respected Lipper Analytical Services, the average equity fund rose 11.51 percent in the first quarter of 1998," writes Weiss. "If that performance is sustained throughout the year, the annualized gain will be 60.79 percent. That's a nice thought but an unreasonable expectation, to say the least. The average annual gain in the stock market [historically] is little more than 10 percent."
She recommends that investors sell any stock that doesn’t pay a dividend, because without a dividend the stock has no cushion to support it. Also, any stock with a dividend yield (the dividend divided by the share price) below 1.6 percent should be considered for sale, since 1.6 percent is the historic low yield for the Dow Jones Industrial Average. The yield of each stock should be considered individually, however, since some high quality growth companies traditionally pay a low dividend.
Sell any stock with a price-earnings ratio (a stock's share price divided by its earnings per share) greater than 23-to-1, Weiss says. While the average price-earnings ratio for the Standard & Poor's 500 is about 24, bargain hunters look for companies with P/Es of 20 or less.
Joe Valenza, vice president of Equity Trading Services at Fidelity Investment agrees. "If you bought a stock mainly because it was undervalued, but it now has a P/E ratio above the market norm, you no longer have the same reason for owning it," he writes. "While you may want to look a little closer at the company before deciding to sell, don’t feel compelled to do so. Many professional money managers sell value stocks after they have lost certain characteristics that made them attractive in the first place, even if the underlying fundamentals of the company remain solid."
Sometimes it is psychologically difficult to sell a company that has performed well, so Weiss suggests that if a stock is up 100 percent from the price you paid, sell half the position. That way you protect some gains, but sleep easier at night.
Again, Valenza agrees. "Frequently, the stocks that fall the hardest are those that have shot up the fastest."
All this said, there are wise and successful investors who say that the best strategy is to purchase solid companies with a reliable future, and just ride out the market gyrations. In the end, the market always moves higher. By riding the tide, you save hours of work and a lot of brokerage fees.
You can do even better with this strategy if you are able to buy blue chip companies when the market is in a decline. For those who have never made stock selections on their own, a market slump presents an ideal shopping opportunity. But even in a depressed market, not all stocks are bargains. The following guidelines will help identify shares that should be purchased and those that are best left alone. You will notice that the following guidelines imply that the corporation is making money (companies that don’t have earnings are more speculative) and that the company has been around for a while. One year of good numbers or ratios is not sufficient proof that a company is growing. There must be evidence that earnings, return on equity and other measures of performance are sustainable.
But first, don’t be intimidated by so many numbers and the prospect of making these calculations on your own. Almost all of the numbers and ratios are published in Standard & Poor's or in Value Line, both available at the public library. For those who use the Internet, Hoover's OnLine (www.hoovers.com) supplies all the numbers and ratios (and other helpful information) at a cost of $110 per year.
Ted Allrich, founder of The Online Investor site on the Internet, suggests compiling a list of companies that you find attractive, then using the following figures as a screen to make final choices.
Again, look askance at stocks with a price/earnings ratio of 24 or higher: Growth stocks often have extraordinarily high P/Es, but these are only justified if the companies' projected annual growth rates are higher than the P/E. Remember, however, that projections are only projections. A lofty P/E means elevated risk.
The price-to-sales ratio (PSR) measures the share price against sales per share. In most cases this number should be below 3, and preferably below 1. You will find exceptions to all these rules, of course, but the only way to know if the exceptions are justified is to take a time machine 10 years forward and then look back.
Return on equity (ROE) is a favorite measure for value investors. A 20 percent return on equity (for five years or longer) indicates how much a company is actually earning, based on the money that the owners, or shareholders, have invested in it.
A company’s debt-to-equity ratio shows how much it relies on borrowed money. A ratio of 1 or less is great, but a ratio of more than 2 means a company could be hurt if sales fall or if interest rates rise. Remember, it is profits, or the expectation of profits, that drive share prices higher, but debt erodes profits.
Janet Lowe is author of several investment books, including "Value Investing Made Easy" (McGraw Hill) and "Warren Buffett Speaks" (John Wiley & Sons).
|
