Rational Investing: Growth, not momentum, key to investing

(Editor's Note: This column was written Dec. 29, prior to the Federal Reserve's surprise interest rate reduction announcement of Jan. 3.)

The parking lot at St. Clair Mall was packed; cars parked at odd angles to fit among the mounds of snow bladed and scooped to make room for the last minute shoppers. I was one of them.

Famous Barr advertised 50 percent off on a tremendous variety of merchandise and I had tucked in my back pocket a coupon good for an additional 15 percent off.

So, I was there, my brain set on bargains, my mission: to complete my Christmas shopping.

The place was packed with shoppers snatching up bargains from leather coats at half price to Jingle Bell Rock Dancing Santas.

It was another example that the consumer won't pay full price, an attitude that has been a large contributing factor in the lack of pricing flexibility that has helped keep inflation in check.

And it reinforced my contention that bargain hunting shopping at big discounts applies primarily to tangibles. It has always puzzled me why the most astute bargain hunters will only purchase apparel, household goods, and even automobiles when they are on sale, while ignoring sales in the markets.

Sometimes it is even stranger they sell their ownership interests in good companies at prices below what they paid for them!

Let's take a look at how these irrational sellers are creating sale prices for the serious shopper the buyer of interests in good, even great, companies.

Many of the bargains they provided us last year are substantially higher in price this year, as I wrote in my last column.

Drugstores, grocery companies, home builders, etc. that we recommended last year have appreciated to the point that most no longer pass the PEG ratio (price to earnings relative to earnings growth rate) test for undervalued companies and are not the outstanding buys of 12 months ago.

In the lexicon of Wall Street, there are two investing styles, growth and value, and the battle will rage forever over which is better.

Growth investing focuses on stocks of companies that are expected to grow revenues and earnings rapidly and which generally pay little or no dividends, frequently resulting in high prices relative to earnings. (A subset of growth investing is momentum investing, which boils down to buying what is moving regardless of the price. This method is the most exciting for those with a trader's mentality, but one fraught with risk witness the collapse of prices in the momentum-driven technology stocks since last March.)

Value investing begins by looking at the underlying asset value of the company, an approach that analyzes balance sheets and income statements and then asks the question of how much should be paid per share for the resultant value.

Companies in this category will generally have a low price/earnings ratio, a low PEG ratio and in many cases will pay a dividend. (Don't dismiss dividends or rates of dividend increases. Remember any asset that increases an owner's income on a regular basis will increase in value over time.)

So, here's where to look now for sale price merchandise in undervalued industries, using as a starting point a low (under 1.5) PEG ratio: Companies in telecommunications equipment and services; data processing peripherals, computer systems, services, and software; specialty and apparel retailers; and semiconductors (equipment and equipment manufacturers).

Let me repeat this is a starting point. In our proprietary screening process, we assign weights to additional screens, including such information as sales growth, debt ratios, institutional holdings, market capitalization, liquidity, etc. We then look for indications of accumulation/distribution using time/volume/price measurements.

We suggest serious investors do the same if they have the time, resources, and inclination. There is no substitute for establishing your risk tolerance, implementing a consistent discipline, doing thorough research, and staying the course.

A few thoughts about interest rates: They will be eased by Chairman Greenspan, possibly even before the next Federal Open Market Committee meeting scheduled for Jan. 30.

The easing will continue through at least the first two quarters of 2001. The bond market will react very positively with each announcement of rate cuts, with high yield (less than investment grade) bonds likely to show the greatest gains.

The stock markets will continue displaying extreme volatility until investor capitulation occurs and money exits the market rather than rotating from sector to sector.

Because we will know only in retrospect when that occurs, serious investors should not wait for it to happen.

Use the methods we have discussed and acquire issues when they meet your under-valued screens. Remember two old Wall Street sayings, "They don't ring the bell at the bottom," and my favorite, "In a bear market, money returns to its rightful owners."

(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 by e-mail at sbj@sbj.net.)