Four Pillars of Investing

05/28/2004 12:00 am EST

Focus:

Jessica Chiaverini

Associate Editor, The Prudent Speculator

"We are about planting seeds, tending the crops and harvesting two, three, five or ten years later," says Jessica Chiaverini, money manager for the Al Frank fund and contributing editor to The Prudent Speculator. Here, she describes their "four pillars of investing."

"We look for out-of-favor undervalued companies, stocks trading for inexpensive financial fundamentals with low price to book value, low price to sales, and low p/e multiples. Some would call us contrarian given that we are buying things that others don't like or buying things that are in downtrends or cyclically depressed. We look for inexpensive companies and focus on valuations. We also pay attention to growth rates. We don't want to just look at a static time - where has the company been. We also want to pay attention to where we think the company could go. So we assign a target price to every company we own or follow. If it's trading at half of what we think it's worth over the next 3 - 5 years, then we will buy it. Here, we will go through four examples of companies to illustrate our four pillars of investing:

"Our first pillar for investing is a low price relative to earnings growth. Beazer Home (BZH NYSE) is an excellent representation of a low p/e ratio company. We have been extremely bullish on the homebuilding sector for quite some time now and Beazer is the sixth largest homebuilder, dealing mostly with first-time and entry-level buyers. There has been quite a bit of decrease in the shares of the homebuilders, especially recently, given the concern about interest rates. But we have argued that other favorable industry trends make it still a very attractive sector, despite the potential rise in rates. Most importantly, the company trades at 6.5 times earnings. This is a company that earned $12.78 in 2003, and is expected to earn somewhere between $15.75 and $16.00 next year, so our consensus is that this is an incredibly inexpensive company that is growing at a phenomenal rate. Meanwhile, interest rates are still relatively low, we have very low inventory, we have a scarcity of land, and you have an immigrant population growth coming in. This would be our top pick. It's cheap on an absolute basis versus the indices at the S&P and it's cheap actually relative to a number of other homebuilders.

"The next pillar that we like to look to is a strong balance sheet. These are companies that have lots of cash on their balance sheet and no long-term debt. Keynote Systems (KEYN NASDAQ) is an Internet performance measurement company. What does that mean? They take measurements and evaluate performances of various Web sites to tell a client how long it's taking a customer to download a picture or to make a transaction, or anything of that nature. They consider themselves the J.D. Power of the Internet, if you will. This is a company that has had nine quarters of positive cash flow and just recently turned profitable. The last two quarters been in the the black and they have no debt. So it's interesting that they are just starting to become profitable. They have no debt and here is the kicker, to have $8.83 in cash per share on the balance sheet. The stock is worth about $12.50, so from just the very common sense standpoint, it makes a lot of sense to own something like this.

"The third pillar is what we call economically-sensitive stocks and here we would offer a company called Norfolk Southern (NSC NYSE). It's a railroad company and they have rail lines in 22 states. While the earnings in the first quarter were not very good for a lot of the railroad companies, earnings here were up 85%. Basically what you are seeing is that the economy has picked up and there has been extremely strong demand. We see improvement in the industrial economy, strong international trade from China. And for a while, the weak dollar is actually helping a lot of its customers, because of a lot of exports are getting to sea ports by rail. So they have had a great quarter and they spent a considerable amount of money in the last couple of years investing in their system and they are starting to finally reap the benefits. Given the fact that we believe that positive demand outlook is going to continue, we think that this would be a good company to own in this category.

"Finally, our fourth pillar is to look at companies that have high dividend yields. American Software (AMSW NASDAQ) actually offers a little bit more than that, but we put it in this category because the yield is so high. American Software went from $3 to $9 and is now back in the $6 range - in line with the downturn in some of the technology sectors. They basically do enterprise resource planning software which covers everything from purchasing and invoicing to order processing and e-commerce. And while they are a low-profile company, they service some of the larger retailers. They have had twelve consecutive quarters of profitability, they have no debt, and they have an ongoing share buy back. The stock is also extremely inexpensive based on price to book and price to share. But one of the other reasons we like it is because of its 4.1% dividend yield. About two quarters ago, the company initiated its first dividend. We get a nice little payment on the share. This stock is down about 30% or so from January and you could buy it up to about $6.20."

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