It Pays to Play the Percentages

05/23/2007 12:00 am EST

Focus: STOCKS

Frank Cappiello

Chairman and Managing Director, Montgomery Brothers, Cappiello, LLC

Frank Cappiello, chairman of Montgomery Brothers, Cappiello, LLC, in a keynote address at last week's Las Vegas Money Show, shared some of his favorite measures for finding winning stocks.

Investing is a game of percentages and that's the way you've got to look at it-percentages of what to invest in, what sectors, and what stocks, percentages in assessing risks in stocks, sectors, the economy, as well as other markets.

First of all, keep losses at a minimum. It's close to impossible to get a good long-term rate of return if you suffer from negative numbers along the way. A portfolio that's down by 50% and comes back by 50% will still leave you down by 20%. The deeper the loss the tougher it is to get back.

When I first came into the business, everybody looked at research and development: what is the percentage of sales the company is spending on R&D? Because that's a clue as to the future of the product line of companies, and usually it's 10%. But about two years ago Booz Allen and Hamilton, a major consulting firm, found that of the 1,000 public companies that spent the most on R&D, only 94 scored the highest in shareholder return-return on invested assets, which is key for a corporation.

This is one of the most amazing stock selection techniques: the lower the number of analysts covering a stock, the better. Rich Bernstein of Merrill Lynch did a study last year and he found out that the stocks that had the least analyst coverage in 2006 had a 30% return, beating all the others. So that's one to keep your eye on.

Insider buying-this is the one I like best. Top executives usually know more than anyone else about what's going on in the company. They know if a new product is going to be successful, they know when a new important customer is about to be signed. And this is material, nonpublic information and they can't act on that except at certain times.

When they buy they have to file a Form 4 with the SEC and that becomes public record very rapidly today. So you know an executive is buying stock and he's buying it with cash and that's big. Exercising stock options is not impressive, but when some executive steps up to buy 20,000 shares of a $50 stock with his own money, that's impressive, that's what you want to see. The closer the insider is to day-to-day operations, the better. Company executives are the best, board members I wouldn't pay much attention to, because they don't do as well. The study found insiders in energy are particularly successful and media moguls were not successful and car manufacturers were the worst.

The volatility that frightens investors is your friend. The very volatility we're talking about shows that most people disbelieve this market and that's one of the surest indicators that the market is going higher. Because if everybody believed in this market they'd be in it and there would be no place to go.

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