Equity Selection Process
Our clients’ accounts have grown because of the investment theory we developed and have diligently employed since 1982. The theory is based on five key factors. In our opinion, most investors consider one or more of the following variables when deciding whether to buy or sell a stock:
- The earnings prediction for a company
- Its current P/E (price to earnings ratio)
- Short-term interest rate levels
- The overall market level
- The comparison of a company’s P/E to the average P/E in its industry group
We believe that the theory works because it is based on common investment factors that motivate the majority of investors. The innovative part of our approach is that we developed a scale that ranges from positive to negative for each of the five factors. The composite score for any stock is derived by combining the individual scores for each of the five variables. While stock prices seldom settle at a level that reflects equilibrium between financial fundamentals and investor psychology, prices have a strong tendency to move toward a state of equilibrium. The results generated by our system help us discern the balance between fundamental investment ratios and investor psychology. Over the years, we have monitored the price movements of numerous stocks in relation to their scores. These scores have given us an indication of where a stock price is headed and how far the stock price needs to move before it reaches equilibrium. The most positive scores have foreshadowed significant percentage gains, while negative scores have indicated that a stock is near its top and will decline.
Our research work starts with a quantitative approach that is based on the scores generated by our evaluation system. We do further qualitative research on companies that appear to be the most mathematically undervalued. The qualitative research involves an evaluation of management ability and ethics, product strengths, and a company’s strategic plan for its free cash flow. Our goal is to find companies that are well run, have a competitive advantage, are financially strong, are mathematically undervalued, and are under-appreciated by most investors.