Any Vulcan will assure you, logic is all; emotion, nothing. If you expect your portfolio to live long and prosper, selecting a strategy and sticking to it is vital to your success. Whether you're in it for a quick score or the long haul, there are two generally accepted styles of equity investing: growth and value.
Growth investors seek companies whose earnings are compounding at a rate greater than other companies in their own industry and greater than that of whatever index to which they are compared. Such stocks need to keep their momentum going to keep their prices rising; therefore, they must sustain above-average earnings growth. Investors who favor this investing style often pay a high price for the stocks, especially when compared to the company's earnings or book value. They anticipate future earnings will grow enough to justify not only current prices but considerable future price increases. Some people call this investing style "the greater fool method": You buy at a high price, hoping to later sell at an even higher price to a greater fool. Growth companies are often found in flamboyant sectors, such as technology, consumer services, health-care and consumer staples, and anyone who invested in these sectors during the past several bull market years was anything but a fool.
Value investors, on the other hand, measure what a company's stock is worth now, then try to buy it at a price lower than this value. Value companies are characterized by a stock price lower than that of the companies' earnings and book value. These stocks pay relatively higher dividends than do growth stocks and are more often found in mature industries, including utility, energy, consumer cyclicals (such as retail and home building) and financial companies. While both stock-selection styles have their devotees, for many, value investing has a logic even Spock couldn't dispute.
To find value stocks, chartered financial analysts Marvin I. Kline and Richard E. Buchwald of Berwind Investment Management LP in Philadelphia suggest narrowing your universe to stocks that fall into a few of these eight categories:
1. Each has a price-to-earnings (P/E) ratio that is at a significant discount to the market's.
2. Each has a low price-to-cash-flow ratio. (Some value enthusiasts value this more than P/E ratio.)
3. Each sells at a low price compared to its value.
4. The stock's dividend yield is greater than that of the market.
5. Each can be purchased for less than 50 percent to 60 percent of its estimated private market value.
6. Each can be purchased at two-thirds of its current net liquidation value (current assets less total debt).
7. Each has a high level of insider buying.
8. The company has implemented a stock repurchase plan.
While only a few stocks meet all these criteria, a reasonable number can meet three or more.