Now we know how to use these databases, formats, and reports. Now you learn how to use them to find stocks that are worth buying. This database will help you narrow down the stocks to a manageable level by merely using the appropriate search conditions. Or you can specifically look for one stock and print information on that one stock. I'll explain how to do both and offer some strategies based on various levels of risk. But first back to basics.
First reread Chapter 8 of this book, I Guarantee You Will Buy Low, Sell High and Make Money to refresh your memory on How to Select the Right Stocks. I'll hit some important points again. First if you're serious about investing, get a subscription to Barron's. It's the best source of information I've found on good stocks to buy. Every issue will show you many good stocks to consider - from various articles, from the Winners and Loser's page in the back of the data section showing you what stocks fell the most that week, or from reviewing the stock tables themselves. Reading Barron's will quickly make you a knowledgeable investor. Any library should have it.
Below are my cardinal rules for picking stocks which I will explain later in this chapter.
1. THOU SHALT ONLY BUY A STOCK THAT IS AT OR NEAR ITS
52-WEEK LOW.
2. THOU SHALT USUALLY BUY A STOCK THAT IS SELLING FOR
$10 OR LESS.
3. THOU SHALT USUALLY BUY STOCKS WITH WEEKLY VOLUME OVER
250,000 SHARES.
4. THOU SHALT ONLY BUY STOCKS FOUND ON THE NEW YORK,
AMERICAN AND NATIONAL OVER THE COUNTER (NASDAQ) EXCHANGES.
5. THOU SHALT LOOK FOR STOCKS WITH LARGE INSTITUTIONAL
AND/OR INSIDER OWNERSHIP.
6. THOU SHALT BUY STOCKS THAT HAVE FAVORABLE FUTURES AND
GOOD PASTS.
7. THOU SHALT USUALLY BUY STOCKS THAT PAY NO OR A VERY
SMALL DIVIDEND.
8. THOU SHALT ONLY BUY RISKIER STOCKS AFTER THOU HAST
BOUGHT SEVERAL MORE STABLE STOCKS FIRST.
9. THOU SHALT USUALLY BUY STOCKS THAT HAVE LONG-TERM
DEBT LESS THAN 1/3 OF THE LATEST REVENUES.
10. THOU SHALT BUY STOCKS IN INDUSTRIES WITH A FUTURE
(FOR EX. GAMBLING, BIOTECH, COMPUTERS, NOT STAGECOACHES).
11. EVERY ONCE IN A WHILE YOU GOTTA BREAK THE RULES!
Rule 1 - Thou shalt only buy a stock or closed-end mutual fund that is at or near its 52-week low
Remember the saying, "It's not what you buy, but when you buy it." This is the most important rule and the rule that will help you the most. Following this rule will make you the biggest profits.
(Note: this relates to a database I used to offer. I no longer offer this database since I started publishing my newsletter.)
Here's how to use your databases to follow this rule if you want to search the whole database(s) and follow three other rules at the same time:
1. Select any database and then select the GOODSK.FRM from the Report Menu.
2. Use the Search Condition and search only for stocks costing less than $10 AND having a weekly trading volume over 250,000 shares. I'd recommend using a volume even higher - see fig. 12.1. Using the NYSE93 database and asking for all stocks under $ 10 and trading over 500,000 shares a week, we get a list of 33 stocks to choose from. Checking all three exchanges will give us a big list to choose from. Larger volume stocks are more actively traded and probably more likely to have larger institutional ownership.
3. Once you have these lists, you have to find out the current high, low, and current price. The database will have an old high and low (but remember I only include stocks where the current high and low are greater than 100%) from when I first put the stock into the database. The current price will be from the latest month if you have been buying my monthly updates but will still be a little out of date. Once you've printed the GOODSK report, print with a pencil like I've done on fig. 12.1 "Current High, Current Low, Current Price". Now you need to get a current newspaper - I recommend the Wall Street Journal, Herald Tribune or current Barron's. It's not mandatory to have today's prices but should be within 2-3 days. Remember before you actually buy ask the broker on the phone what the price is, you can always change your mind if the price has gone up too much. Pick another stock. Of course if you like the stock and the price has gone down, it's even a better buy. Don't worry, you'll get the hang of it.
One other slight problem is that the name of the stock is printed differently by different papers. Barron's and the Wall Street Journal have the most complete names. With the Herald Tribune it's a little harder because they abbreviate more. They might use AM for American. Most stocks can be figured out. Look at the current high/low price in the paper and the high and low should be greater than 100% and the current price should be close to the current month's price on your GOODSK.FRM printout.
4. When you've written all the current highs, lows, and current prices you're interested in, then it's time to do a little research. Free research is as close as your library - check the Standard & Poor's 2 page reports, Value Line, and the library probably has other research tools - maybe a computer on-line service, annual reports etc. Ask the librarian, they'll be glad to assist you.
Check out the beginning sections of Value Line - they have a summary listing stocks with lowest Price/Earnings (P/E) ratios, lowest book value, stocks with the highest estimated future returns etc. They also show a section showing high growth stocks and worst performing stocks (biggest % price drops). Every issue of Barron's does the same thing in the Winner's and Loser's section. For additional free info, send off for the latest annual report from the company. Just a postcard from you and the company will send an annual report to you using first class mail.
5. After you've found the stocks you're interested in, I'd follow the instructions in the format chapter and print out a 93 & 94 format sheet (fig. 3.4) for each stock you're considering.
6. Remember at or near it's 52-week low - it's the cardinal rule for profits.
Notice how we have also taken care of Rules 2, 3, and 4 by using the database.
Rule 5 - Thou shalt look for stocks with large institutional and/or insider ownership - at least 40%
For this rule and the rest of our rules, we must look to outside research - our databases can't help us. But the databases have helped us narrow our search to a reasonable number. Just following rules 1 through 4 will make us a good profit. But a little extra research that doesn't take that much additional time or money, will help us make an even bigger profit.
A free source of information is the Standard & Poor's two page reports. Most good libraries have them and update them (new reports on every stock come out about every 6 to 8 weeks). All reports have the same format. On Page 2 of the report at the bottom is a section called CAPITALIZATION. Under this section you'll find a subsection COMMON STOCK. In this section you'll find the percent of institutional ownership. For example, one reason I bought a large computer company called Amdahl is because the S & P report showed a Japanese company called Fujitsu owned 44% of the stock and institutions (mutual funds, pension funds, banks, etc) owned 43%. This means 13% or less is owned by the general public. Also in my literature you'll find information on how to use Compuserve toresearch stocks.
Why does this help us? This helps us for several reasons. When a large company holds a big block of stock, that block rarely trades and thus there is less stock available to trade and if someone wants to buy, the price will be pushed up. For example one stock I own, US Surgical, plunged $ 15 a share in one day because analysts downgraded the stock because they felt revenues wouldn't grow as fast as they had in the past. That caused many institutions to dump the stock (it wasn't my 33 shares that caused the drop).
Normally when stocks go way up or down, the volume traded goes much higher. A stock may average 1,000,000 shares traded a month, then it goes way up or down in price and you see it traded 2,000,000 shares in one week! For example, look at fig. 3.3 again, the volume went from 2.5 million shares to 5.2 million when it fell from $ 15.75 to $ 7.62. Then it went from $ 8.87 to $11.12 in Sep 92, volume went from 2.9 million to 8.2 million. These volume numbers show the big players were involved. You take advantage of this - you buy when they sell and you sell when they buy.
Another and better way to find institutional ownership info and a wealth of other valuable information at a small cost is the eight page Standard & Poor's Report. The report costs $ 10 from S & P but is well worth the cost and deductible against any stock you buy. You'll get an eight page up to the minute report (the front cover will have the date and time the report was prepared). To order have your credit card ready and call (800) 642-2858 and give them the stock symbol and stock exchange. They'll even fax it to you for another $ 2.50. Unfortunately for us overseas the call isn't free but still is deductible. S & P nows offers these reports over the Internet.
A friend of mine told me that if you have an account with Fidelity (I'm not sure if you need to have a brokerage account or merely own mutual funds), you can call toll-free from overseas (0130 number) and order S & P Reports for only $ 6. If you don't have an account, maybe a friend does and would order reports for you. A dollar saved is another dollar to invest. Also Price Waterhouse offers the S & P Reports for $5. I'm sure there is an easy way to obtain S&P reports from on-line services as well as other reports that would give you the necessary information. I'll add a chapter to this book later on when I have a better knowledge of on-line stock research available on-line.
For now we're only interested in the institutional ownership info in the S & P Reports. Later I'll tell you how to use the reports for other information we want. The place to find institutional ownership is page 2 Other. Look for the line "% held by institutions". For ex., I'm looking at Gensia Pharmaceuticals, on NASDAQ and the % of institutional ownership is 66%, very good.
S & P Research Reports give you additional related info - insider holdings. If a company has a large block of its stock owned by the company officers and directors, it will be listed here. One reason I bought US Surgical (High - $114, Low - $28, I bought at $30) was because institutions owned 62%, Officers and Directors owned 31%; leaving only 7% trading with us, the general public.
The place to look for insider holding information is Page 5 under CAPITALIZATION. If officers and directors own significant blocks of stock, it'll be mentioned here. The S & P Reports are really excellent sources of up to the minute info and again I highly recommend them.
Rule 6 - Thou shalt buy stocks and closed-end mutual funds that have favorable futures and pasts
What does this mean? Again remember investing is an art not a science. For a favorable past, I like to look at the price history, P/E, revenues, profits (earnings). Let's use US Surgical as an example. On Page 5 of the S & P Research Report is a section called "INCOME COMPONENT ANALYSIS". Look at the bottom and you see five years of price and P/E (Price/Earnings) history. The P/e ratio is the ratio between share price and earnings per share. If a stock sells at $ 10 a share and earned $ 1 a share, the P/E is 10. If the stock earned $.50 a share, the P/E is 20.
When I looked at the price and P/E history of US Surgical, here's what I found:
High 8.62 15.31 35.87 116.37 134.50
Low 6.62 7.68 12.06 31.25 69.00
No P/E for 1992 because the year wasn't finished at the time of the report.
Now the price history looks pretty good doesn't it? Well it gets even better. Another item must be checked - stock splits. On Page 2 in the S & P Research Reports under "KEY STATISTICS AT A GLANCE", you'll find any stock splits in the last five years. Remember again on the databases - if you see a small s after the name of the stock, the stock had a stock split in the last 12 months.
Looking again at US Surgical, we find 2 for 1 stock splits in 1990 & 1991. Thus if you owned 50 shares; after 1990 you now owned 100 shares and after 1991 you owned 200 shares. Stock splits usually mean the company has been doing well and investors are eagerly buying the stock, pushing the price up. Most companies want to keep their stock prices lower to encourage more people to buy and thus split the stock.
I regard stock splits as favorable. However reverse stock splits (such as 1 for 10), I regard as a warning that this is a risky stock. Your US Surgical would have gone from 50 to 5 shares if a 1 for 10 split occurred. This usually happens on companies where share prices dip below $ 1 a share. For ex. one of my stocks, Saachi & Saachi had a 1 for 10 split and my holdings went from 600 to 60 shares and the stock price rose from $.75 to $ 7.50. Company barely made me a profit, and I got rid of it when it showed a slight profit. Looking at the P/E high and lows shows you that the stock was profitable all five years. Stocks only have P/Es if the company was profitable. Thus in Barron's if you see a stock with a blank P/E, the company lost money in the last measurable period. Looking at the P/E, US Surgical was profitable all five years. Looking at the P/Es showed people were willing to buy with a P/E as high as 73.7.
I bought US Surgical at $30.25 when it showed a P/E of 13. Looking at the five year history shows me buying at 13 is a good deal. Normally I like stocks with low P/Es; any stock at 10 or less i definitely want to know more about.
Also on Page 5 of S & P's Reports, you'll find revenue and income info. Here's what I found for Surgical: (M = millions)
Year 1988 1989 1990 1991 1992
Revenues 291 M 345 M 514 M 843 M N/A
Income 23 M 31 M 46 M 91 M
The rise in revenues and income shows a good pattern to me. This is a good semi-aggressive stock with great high/low swings. This is the type of stock to start with and build on. Notice buying this stock violated the rule about buying stocks costing more than $ 10 dollars. As rule 11 says, sometimes you gotta break the rules.
Now the future. Read the Business Summary and Important Developments on Page 3 of the S & P Report. On Page 6 you'll get an industry outlook of the industry your company is in. This will show you whether you have a "stagecoach industry" company or one in an industry with a good future. On Page 7 you'll see summaries of the latest newspaper articles that talked about your company.
Now after reading all this and Value Line will have much of the same info, do you feel good about the stock? Does it give you a warm fuzzy?
I think after you have done this a few times, you'll have the ability to decide what stocks are good buys. Your hardest problem will be picking from a group of good buys. Remember you only want a good buy, don't agonize trying to pick the stock of the year.
Rule 7 - Thou shalt usually buy stocks (doesn't apply to closed-end funds) that pay no dividend or a small dividend
Most stocks that pay large dividends will never appear in your search because they don't fluctuate 100% a year and usually cost over $ 10 a share. One group of buy candidates, closed-end mutual funds, do usually have large dividends and low prices and 100 % price fluctuations. Have your cake and eat it too!
If you do buy a stock that pays a dividend, I recommend you tell Blueprint to reinvest your dividends into Ready Assets and not more shares. This will make tax time easier.
Rule 8 - Thou shalt only buy riskier stocks after thou hast bought several more stable stocks
Each of you knows what level of risk you feel comfortable with. A good book on the subject is The Nature of Risk by Justin Mamis I got from the Fortune Book Club.
Stocks come with different risk levels. I'll give you an idea of what I consider "safer" stocks. Then I'll give you an idea of what I consider "riskier" type stocks. You can decide for yourself if riskier stocks have a place in your portfolio. Riskier stocks can offer even greater profits than safe stocks, but are not for the faint hearted.
Safer stocks are companies with:
- at least $100,000,000 in revenues;
- companies making a profit;
- companies with share prices higher than $ 3 a share
- companies with high/low swings less than 300%
For example, if the low is $ 5 a share and the high is $ 15 this is a safer stock. A riskier stock would be one with a low of $ 1 and a high of $ 12. Safer companies would show steadily rising revenues and incomes such as US Surgical. Riskier companies often have a bad year or two, lose money and thus the stock drops way down. I bought Synergen, a biotech on the NASDAQ after the price went from $ 67 to $ 11. Riskier stocks can easily rebound and thus make you bigger profits. If Synergen discovers a hot new drug, the price could shoot back up quickly.
Riskier stocks include stocks in bankruptcy, stocks trading for less than $3, and stocks with high/low differences greater than 300%. Stocks in bankruptcy have a "VJ" in front of their name or on NASDAQ, the fifth letter in the stock symbol will be Q. This means the company is in Chapter 11 bankruptcy. The courts give the company 3-5 years to straighten themselves out. This usually means that creditors have agreed to smaller or no payments on debts owed them for a period of time. Normally companies in bankruptcy trade for less than $ 3 a share, many times under $ 1 a share. Look through Barron's and you'll see many stocks trading at $.25 or less. You might see a high of $ 1 and a low of $.12. That's a great percentage spread and offers great profit potential but with a greater risk.
I'd advise you to wait until you own three or four safer stocks before you add a riskier stock. Now since the stock is riskier and since it's low priced, you don't need to invest the usual $ 1543 per stock. Cut this in half, put $ 500 into stock and $ 250 into Ready Assets and then follow the regular guidelines for setting up a stock. Later on I'll give you a really wild strategy for playing riskier stocks after you've gotten rich from the system. I'd recommend 1 - 2 riskier stocks in a 10 stock portfolio for the average investor.
Rule 9 - Thou shalt usually buy stocks with a long-term debt less than 1/3 of current revenues
Stocks with 1/3 or less long-term debt are safer stocks and stocks with higher debt levels are riskier stocks. You can find the long-term debt amount under CAPITALIZATION on Page 5 of the S & P Research Reports and Page 2 of the S & P 2 page reports. An example of a riskier stock is RJR Nabisco Holdings - earnings were 15.7 billion but long-term debt is 13.5 billion.
Rule 10 - Thou shalt buy stocks in industries with a future
This goes along with Rule 6. Look for the industries and products of the future. Off the top of my head biotech, medical, gambling, information highway, are a few. Right now the medical/drug industry is very depressed because of uncertainty over what Clinton will do with health care. A little research will reveal many good bargains. But watch out for companies in a deadend position in a good industry. Right now IBM fits that bill - mainframe computers are dying out. If you keep reading Barron's, you will find articles showing you industry trends. Read Barron's regularly and you'll have no trouble seeing the good industries of the future.
Rule 11- Every once in a while you gotta break the rules
When a great opportunity comes along, you can ignore one or more rules (except Rule 1!). I violated my rule of only buying stocks under $ 10 when I bought US Surgical at $30.25. Why? It was selling at 25% of its high for the year. It offers low-cost alternative surgical procedures, and revenue growth was still excellent. I recommend that you also do the same and scan stocks over $ 10 for outstanding buys. My monthly list of good buy stocks that comes with the database updates always includes a few stocks over $10.
Always remember investing is an art not a science. You make the best choices and then play the system and be patient. You're in this for the long-term.
Now I promised you a riskier strategy. This will not be for most of you but I want to get you thinking about exploring the possibilities of the system and this is a good way to do that.
Search your databases and ask for all stocks selling currently for $.50 a share or less. Then do the same thing you'd do with any stocks you're thinking of buying. Find the current high/low and current price and only consider stocks selling at or near their years' low. You could also use this strategy to find one or two risky stocks to put in your ten stock portfolio. See fig. 12.2.
Here's the risky strategy. Buy ten risky stocks selling for $.12 or less now. Put $100 into each stock and then do nothing until the stock hits $.50 a share and then sell all of the stock. If only four of your ten stocks do this, you'll be ahead 60% even if the other six go completely bankrupt.
4 X $400 = $1,600
6 X 0 = 0
$1,600
I nicely ignore commissions, phone calls, etc. because they lower your profits.
If a risky strategy doesn't appeal to you, stick with whatever strategy you feel comfortable with. My strategy, my 11 commandments are designed for the small investor who wants to put $ 1,500 into a stock.
If you are a large investor and would like to put $100,000 into ten different stocks - please call me immediately, I'll quit my job and work for you and design a perfect strategy for you. Bigger investors can go with more conservative stocks that don't fluctuate 100%. Reread chapter 9 of my other book and learn the conservative strategy to see how successful you can be with really conservative stocks as a large investor.
I hope this gives you some help in picking stocks. By following these ideas, you'll be able to pick good stocks with just a little practice. Treat this as a rewarding hobby that will pay you big profits. Keep it fun and remember the system will always tell you the right thing (buy, sell, or do nothing). Just be patient and remember you're going to make a heck of a lot more money from stocks than from banks.
In the near future I will be starting a monthly newsletter giving you a list of stocks I like, ideas for improving the system, and other useful info I think will help you. Also I offer monthly or quarterly database updates at modest prices. Please read the flyer for information and prices.
I truly hope and believe you'll be successful. I want you to achieve your dreams and goals. Use the system to obtain the future you want and deserve.
I received a very nice letter from a former student who followed my Mark Twain advice and lavished praise on me. But more importantly he took the time to send me a list of rules he devised for selecting stocks that I'd like to share with you. I'd like to publicly thank Steve Donahue of Georgia for sharing these rules and now hope they benefit you also.
He prefaced his list of rules with a few comments he gleamed from six months of learning about stock selection (may you all be so dedicated).
1. Steve had several ideas on determining the health of a company. He said my idea of simply looking at long-term debt as a percent of revenues as a rather weak measurement of debt and quite deceiving at times. He said Barron's, Forbes, Business Week, etc. all refer to Debt to Equity Ratio. But Steve found each publication used a different formula to determine the ratio. (See Barron's Finance & Investment Handbook for the three different types of Debt/Equity ratios). Steve decided to use the following definition: Debt to Equity Ratio: Long-Term Debt plus Total Current Liabilities divided by total Common Equity Steve says the lower this percentage the better, anything below 40% he feels is good.
2. Steve found earnings to be of paramount importance. Very often, publications refer to the Earnings to Equity Ratio. This is a good measure of how efficient and productive a company really is. This is also a measurement of growth in earnings and control of costs. The ratio is also found using several different formulas. Steve felt Value Line had the best formula noted as % Retained Net Worth on its statistic page of each company (third to bottom column. The higher this percentage the better (12% is about average for an average company). Value Line uses this formula:
% Retained Net Worth (earning to Equity Ratio): Net Profit (net income after taxes) divided by Net Worth (common equity)
1. Select a stock at or near its' 52-week low - here, here!
2. The difference between the high and low should be 100% or more. Normally the beta of such stocks is 1.0 or more (beta compares the ups and downs of a stock's price relative to the general market. A stock with a beta of 1.5 tends to move 50% more than the total market, a stock with a beta of 0.5 moves 50% less. A stock with a beta of 1.0 moves exactly as the market does).
3. Select stocks with at least 200,000 shares traded weekly on average. 150,000 shares is acceptable for smaller companies.
4. Select low P/E ratio stocks. The Price/Earnings ratio should be well below the P/E of the market as a whole, (see Value Line, Part 1).
5. Select a company with a debt to equity ratio of less than 40%. Debt to Equity Ratio equals total current liability plus long-term debt, divided by shareholder common equity. The smaller the company, the smaller this ratio should be. 6. Select a company with an Earnings to Equity Ratio of 15% or better. Earnings to Equity Ratio equals net income after taxes divided by shareholder common equity.
7. Select stocks with at least $100,000,000 market capitalization. Market capitalization equals common stock outstanding multiplied by current share price.
8. Select companies with a history of earnings growth. Avoid a company with an earnings deficit unless you are sure this is a strong company with a promising future.
9. If possible, check out the companies product. Steve checked out Liz Clairborne and hated the product, I believe women's dresses.
10. Find out the stocks' knock. The price is low for a reason. The best choice will be a good company in an out of favor industry.
11. Avoid stocks rated a buy by any newsletter (including Value Line.) I totally agree, the newsletters usually take a short term outlook and generally favor stocks that are at their years' high, not low.
12. Pick stocks with at least 35% institutional ownership.
I really like Steve's final comments. "Sometimes you can overanalyze a stock. Sometimes the gut feeling is the best formula."
I'd really like to thank Steve for sharing his ideas and I encourage you to do the same so I can share them. We're all in this together. Let's help each other achieve our dreams.