Pick future stock winners

There’s much recent media attention on big corporate bankruptcies. But the fact is, in the great scheme of things, very few companies are going to take the gas pipe.

For every Enron, Adelphia, and WorldCom that makes the headlines, there are dozens of corporations that will still be standing when these rough times are over.

Many will actually emerge much stronger, having made tough cost-cutting decisions and gaining market share as a result of competitors going under.

Identify the survivors
The key is to identify the survivors now and to gradually add them to your portfolio. This is how the big bucks are made in the stock market – buying great companies while they’re cheap and waiting for the cycle to turn back in their favour, as it inevitably will.

That may sound easy. It’s not. In these types of markets, many investors make the mistake of chasing after falling stars, on the theory that the stock has plunged so far that it has no downside left.

That’s not necessarily so, as we saw with WorldCom. The bottom is zero.

Your best bets are companies that are fundamentally sound but temporarily out of favour, r whatever reason.

Here is a checklist of points to look for in your efforts to separate the stock market wheat from the chaff.

Next page: Check positive signs

Check positive signs:

  • The company is bottom-line profitable.
  • Second best: it has an operating profit and any loss is temporary, due to write-offs of goodwill, etc.
  • The stock pays a dividend. Bonus: the dividend was recently increased.
  • The company has a sound balance sheet with a debt/equity ratio of 1/1 or better.
  • The company’s business is transparent. You can understand what they are doing.
  • The company is an industry leader. Employ the old Citibank rule – only buy the top three companies in any sector.
  • Company insiders are buying.
  • The company has a share buy-back program in place and is actively pursuing it.
  • Revenues and profits regularly surprise by coming in above projections.

Beware these negative signs:
  • A balance sheet with a large amount of goodwill. Goodwill is actually “badwill” when it comes to corporate accounting. There are no real dollars there, just numbers.
  • Operating losses that continue to rise each quarter.
  • A track record of failing to meet analysts’ expectations.
  • The company spent freely on acquisitions during the 1990s. It probably paid too much for what it got.
  • The dividend has recently been cut.
  • The stock is being diluted through new issues and the money raised is being used to sustain operations.
  • Corporate insiders are dumping stock.
  • There are huge short positions against the stock.
  • You don’t understand the business. Does anyone really know to this day what Enron was actually doing?

Patience also needed
One more point. Even when you identify a quality stock, don’t expect it to suddenly take off. When a sector falls out of favour, it usually remains in a state of disgrace for a long time.

You will need to be patient. But if you choose wisely, you’ll eventually reap the rewards.

Adapted from an article that originally appeared in the Internet Wealth Builder, a weekly e-mail financial newsletter featuring some of Canada’s top stock market experts. For membership information: http://www.buildingwealth.ca/Newsletter/index.cfm