Rational Investing

by Clark Davis

Special thanks to those of you who have commented on past columns and provided suggestions for future topics. (I hope to see many of you when I am in Springfield next week addressing a private client meeting for one of my favorite investment firms.)

Thanks, too, for some interesting questions you have asked me to address. Space limitations preclude answering all of them this week, but here are a few I particularly liked:

Question: I have noticed that a lot of times the price goes up for a stock that announces layoffs. Is that a buy signal?

Answer: Not necessarily. During the past couple of years, I have commented frequently on the positive effects "downsizings" and "restructurings" could have on corporate earnings. But such benefits are not always long-lasting.

The process of streamlining operations to increase efficiencies will go only so far. Cost cutting can help the bottom line over the short run, but it must be combined with sales growth to drive earnings over a longer period.

That's one reason why we look at sales growth rate and the stock price relative to the sales per share (how much an investor has to pay for a dollar's worth of sales). For many companies, the economies recognized from such streamlining are now behind them.

Earnings comparisons that before were made against periods of lower efficiency will now be made against earnings periods in which those efficiencies were well in place. In other words, it's time for an apples-to-apples comparison. That means earnings reports for many companies will be neither as dramatic nor as positive as they were last year.

What does this mean for equity investments? Probably that demand for stocks will be more selective, with greater emphasis on earnings consistency and balance sheet strength. In other words, a refocusing on value and quality, and less emphasis on the market price momentum that I referred to in my last column as the "greater fool theory."

It also means that investors are likely to be less forgiving when a company reports disappointing earnings, even if only by a few cents, or if a company reports a sales or earnings growth rate below that of prior quarters.

Question: A friend of mine always buys stocks that he hears are going to split. He says that gives him more stock. I disagree, because after the split the price is adjusted to reflect the split. Which of us is right?

Answer: Both of you. He will own more shares of stock, but the same proportionate amount of the company. Stock splits are generally used by companies that want to broaden their shareholder base and which recognize that many investors are reluctant to buy higher priced stocks.

A rule of thumb: If you felt the investment was a good one before the split, but didn't buy it because it was "too high priced," go ahead and buy it and then rethink your reasoning for why you did not acquire it at the pre-split price.

Question: Why have you not recommended any specific stocks in your column?

Answer: Because it would be presumptuous of me to think I know what's best for every reader; somewhat akin to a doctor sending all his patients a letter and telling them that drug A is just what they need.

I believe very strongly that you should work closely with your investment professional in establishing methods of investment selection and discipline that are appropriate for your goals, risk tolerance and experience.

From time to time I will mention specific stocks by way of explaining a method of analysis or review, but always with the caveat that it is not a recommendation.

Question (this one is my favorite): Were you sitting on a sharp instrument when you had that picture taken or are you really that grumpy?

Answer: Next question please.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Questions or comments can

be directed to him by mail via The Springfield Business Journal, 313 Park Central West, 65806 or e-mail at clark@slia.com.)

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