Stock Trek Enterprising investors take a voyage to value investing.

Looking for transportation to a place where few investors havegone before? With the stock market hurtling along at warp 9 to newgalaxies almost daily, you may have to find a stable investmentwormhole to rocket you to another universe. No clue where to findsuch a channel? You may want to consider a strategy that'sworked since the earliest days of the Federation: If you'llagree to travel at a lower warp, value investing could be yourticket to the stars. And you won't be alone out there. Somerather noteworthy value investors have preceded you--strategistBenjamin Graham, mutual fund manager John Neff, and the Oracle ofOmaha, Warren Buffett, to name a few. Join us on the bridge and getready to go. Lock in your coordinates--engage!

Lorayne Fiorillo is a financial advisor at PrudentialSecurities Inc. Past performance is no guarantee of future returns.For more information, write to Lorayne in care of Entrepreneur,2392 Morse Ave., Irvine, CA 92614.

Vulcanize Your Portfolio

Any Vulcan will assure you, logic is all; emotion, nothing. Ifyou expect your portfolio to live long and prosper, selecting astrategy and sticking to it is vital to your success. Whetheryou're in it for a quick score or the long haul, there are twogenerally accepted styles of equity investing: growth andvalue.

Growth investors seek companies whose earnings are compoundingat a rate greater than other companies in their own industry andgreater than that of whatever index to which they are compared.Such stocks need to keep their momentum going to keep their pricesrising; therefore, they must sustain above-average earnings growth.Investors who favor this investing style often pay a high price forthe stocks, especially when compared to the company's earningsor book value. They anticipate future earnings will grow enough tojustify not only current prices but considerable future priceincreases. Some people call this investing style "the greaterfool method": You buy at a high price, hoping to later sell atan even higher price to a greater fool. Growth companies are oftenfound in flamboyant sectors, such as technology, consumer services,health-care and consumer staples, and anyone who invested in thesesectors during the past several bull market years was anything buta fool.

Value investors, on the other hand, measure what a company'sstock is worth now, then try to buy it at a price lower than thisvalue. Value companies are characterized by a stock price lowerthan that of the companies' earnings and book value. Thesestocks pay relatively higher dividends than do growth stocks andare more often found in mature industries, including utility,energy, consumer cyclicals (such as retail and home building) andfinancial companies. While both stock-selection styles have theirdevotees, for many, value investing has a logic even Spockcouldn't dispute.

To find value stocks, chartered financial analysts Marvin I.Kline and Richard E. Buchwald of Berwind Investment Management LPin Philadelphia suggest narrowing your universe to stocks that fallinto a few of these eight categories:

1. Each has a price-to-earnings (P/E) ratio that is at asignificant discount to the market's.

2. Each has a low price-to-cash-flow ratio. (Some valueenthusiasts 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 themarket.

5. Each can be purchased for less than 50 percent to 60 percentof its estimated private market value.

6. Each can be purchased at two-thirds of its current netliquidation 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 reasonablenumber can meet three or more.

Beam Me Up, Scotty

Value investing may be logical, but does it get results? Whilepast performance is no guarantee of future returns, Kline andBuchwald cite a 1976 study by Benjamin Graham, the father of valueinvesting, in which he concludes that applying value investmentprinciples resulted in an average annual rate of return ofapproximately 19 percent over the 50-year period from 1925 to1975--well above that of the general market. Tom Jackson, aPrudential Investments portfolio manager, agrees: "If youfollow the value style over the long term, you could outperform[the rest of the market]."

In a study done by Jackson, one dollar invested in 1970 in theS&P 500 (with all dividends reinvested) would have been worth$30.20 at the end of last year, representing a compound annual rateof return of 12.95 percent. The same dollar invested in lowprice-to-book-value stocks would have been worth $73.27,representing a compound annual rate of return of 16.57 percent. Hadthat same dollar been invested in a low P/E ratio value stock, itwould have grown to $92.66, for a compound annual rate of return of17.56 percent. (Taxes and fees are not considered in this example.)Jackson notes that these returns aren't garnered every quarteror even every year but that three- to five-year periods may seesuch returns. Value investing seems to put the probability oflong-term success in the investor's corner.

But like all things in life, value is relative. "A valueinvestor," says Janet Lowe, author of Value Investing MadeEasy (McGraw-Hill), "should study the work of BenjaminGraham." Lowe condenses Graham's ideas for racking uprelatively safe, high profits into six rules:

1. Don't pay too much attention to the overall market.It's easier to find good buys when share prices are generallylow, but you can still spot a few bargains even when the market ishigh.

2. Buy a stock as if you were buying the whole company.

3. Look for signs of specific value (below-average P/Eratios, above-average yields, and earnings that have doubled since1985 with no more than two annual declines of more than 5percent).

4. Focus on quality.

5. Diversify with both stocks and bonds.

6. Above all, think for yourself and be patient.

The Next Generation

So where do you go to find value? You don't have to graduatefrom Starfleet Academy or survive the wrath of Khan to find goodstocks at attractive prices. In larger company stocks, Jacksonlikes paper products, tobacco companies and financial servicescompanies, including banks, insurance companies and brokers. WarrenSpitz, a portfolio manager with Prudential Investments, suggeststhat investors looking for values in the mid-cap sector check outfinancial services companies, real estate investment trusts,consumer cyclicals and industrial materials companies (such asaluminum and steel). On the small-cap level, Jay Kaplan, also aPrudential Investments portfolio manager, suggests that investorsfocus on cash flow instead of earnings. "Cash pays bills;earnings don't," says Kaplan. He likes companies involvedin textiles, apparel, auto parts, restaurants, energy explorationand production, and suppliers to aircraft manufacturers.

Does selecting stocks have you so baffled you're thinking ofusing your disrupter? Relax. You don't have to do it all onyour own. Transport to your nearest Morningstar report for a listof value funds in each sector. Whether you're looking forlarge-cap, mid-cap or small-cap funds, there are plenty to choosefrom--and you don't have to leave the neutral zone to do it.Just consult your financial advisor and read the prospectus andannual report before you invest.

Kling-on To Your Profits

To make the most of their investment dollars, value investorsbuy when stocks are out of favor and prices are low. Experts areused to a buy-and-hold strategy, sometimes holding and holding andholding, while it seems like the momentum investors are having allthe fun. For some value investors, it's almost a point ofhonor, like not leaving the field of battle until you've won.So when do you sell? There's an old adage on the street ofdreams: Buy on the bad news and sell on the good. For valueinvestors, this adage should become a mantra, though many lack thenerve to do more than chant it. Jackson notes that if you canidentify a cheap stock, you should be able to verify appreciatedvalue. "If you're buying stocks at 50 cents on the dollar,when [the stock's value] gets to dollar-for-dollar, sell,"he says.

Are the principles of value investing alien to you? No one issuggesting the value style should be the only one determining yourportfolio. Like a good starship crew, diversity breedssatisfaction. What kind of investor are you? Kirk Kazanjian, authorof Wall Street's Picks for 1998 (Dearborn FinancialPublishing), says: "You can spot a value investor a mile awaybuying what everyone else is trying to sell. They look for stocksmaking new lows instead of those making new highs. Value permeatestheir lives--they don't spend a lot on cars, houses orclothes." If this describes your lifestyle, maybe valueinvesting is right for you.

Nonetheless, where the market is headed is anyone's guess.Falling interest rates, slowing economic growth and lower corporateprofits are conditions that generally favor growth over value. Bigearnings increases and economic expansion generally favor valueover growth. Not sure what the world is coming to? Don't choosesides: Diversify between sectors and styles. In the long run, youmay save yourself a lot of headaches.

Contact Source

Berwind Investment Management LP, (215) 575-2346,mkline@berwind.com