Investing & Running Your Own Screen Play

Not sold on our tech-stock picks? No problem: The Web offers plenty of ways to find your own candidates. Here are three good ways to research and find the best prospects.

1 Shadow the Fund Managers

Why waste time screening and researching if you can get mutual fund managers to do the work for you? Fund managers spend all day researching investment opportunities and have access to more information than you’ll ever see. Although analyst recommendations are often tainted by potential conflicts of interests, mutual fund managers buy a stock for only one reason: They think it’s headed north.

Unfortunately, most funds conceal their trading activity until months after the fact. Below are two fund families that reveal trades early enough for investors to act on. Both are low turnover funds, meaning their managers follow a buy-and-hold strategy. You can use their largest holdings as a source of investment ideas and pay attention to the stocks they are dumping or loading up on.

IPS ADVISORY

Robert Loest manages the IPS Millennium (a blend of tech and dividend payers) and New Frontier funds (all tech). His recent results have suffered along with everybody else, but his Millennium fund boasts a 21 percent average annual return over the past five years. Loest’s Portfolio Manager Diary offers insider commentary on his recent trades as well as his take on the market. Most useful is his analysis of specific market sub-sectors. Loest describes where the sector fits into the overall market and offers his take on the leaders. It’s a fascinating education on tech stocks you won’t find anywhere else.

Munder Capital Management

Munder was a relatively unknown fund family until its NetNet fund, one of the first Internet funds, made headlines by scoring huge returns in 1998 and 1999. Last year was another story, but NetNet still carries a four-star rating from Morningstar. Don’t worry about the name; NetNet has always focused more on Net infrastructure companies than on dot-coms.

Munder runs more than 20 funds in a variety of sectors. NetNet and Future Technology focus on technology. A monthly commentary on each fund lists all transactions for the previous month and the rationale for each trade. You can also see the top 10 holdings for each fund.

DO THE TECH CHECK

PRICE/SALES RATIO (P/S)

This is the valuation barometer. Look for stocks with a P/S below 10. Below five is ideal.

CASH FLOW PER SHARE

Companies with positive operating cash flow are safer investments than cash burners. Look for the “+” sign.

INSTITUTIONAL OWNERSHIP

If mutual funds and pension plans invest in your stock, it is for one reason: They think it will earn money. Look for stocks in which institutions own 30 percent or more of outstanding shares.

GROSS MARGIN TREND

Changes in gross-profit-margin percentage signal competitive shifts in the marketplace. Compare percentage gains or losses over the last four or five quarters. Look for trends that are flat or increasing (but ignore variations of less than 1 percent).

REVENUE GROWTH RATE

Slowing revenue growth signals danger ahead. Use a calculator to figure out the most recent quarter’s growth rate from the same quarter a year earlier; then compare to one-year sales growth. Look for most recent quarter growth of at least 85 percent of one-year growth.

2 SCREEN FOR SOLID CITIZENS

You can screen for stocks all over the Web, but Morningstar’s Stock Selector rates stocks in four categories using easy to understand grades: A, B, C, D, and F. You can search for stocks based on the grades.

Tech investors should focus on two categories:

Financial health: Morningstar analyzes critical financial data including cash, cash flows, and debt levels to calculate the grade. This is the kind of analysis you should do on every stock since financially strong companies are the most likely to lead the recovery.

Growth: The best grades go to companies with not just high but accelerating sales growth. Companies can report earnings growth by cutting costs, but in the end, a company can only grow as fast as it grows sales. Faltering sales growth signals problems ahead.

Morningstar also calculates the grades by comparing companies within various sectors. The top 22.5 percent stocks in each category receive A’s, the bottom 10 percent receive F’s. Select the technology sector and then select A grades for the financial health and growth categories. (In late March that yielded 48 stocks alone.)

Market pundits tell us small- and mid-cap stocks will outperform large-caps in the recovery, so I used the screener’s style box to narrow the search to “small growth” stocks. That search came up with nine interesting candidates.

3 PANNING FOR GOLD

Still stuck without good prospects? Here’s a simple screen you can run, tailored to the tech sector and combining elements of several successful value-selection strategies. Quicken.com’s Stock Screener uses price/sales ratio to spot value-priced stocks and looks for companies with consistent earnings growth and strong financials.

  • Price/Sales ratio: 2.0 maximum. Tech stocks below 2.0 are considered value-priced.
  • One-year EPS growth: 15 percent minimum. Cheap stocks without earnings growth will likely get even cheaper.
  • Long-term debt/equity ratio: 0.5 percent maximum. High debt levels put a company at a competitive disadvantage.

Consider the results of any screen, no matter how well thought out, not as a buy list but as a list of candidates worthy of further research.

Posted by on May 15, 2001