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How to pick a stock before it gets hot.

Chris Wilson works 2,000 miles away from the Redmond, Wash.-based Microsoft Corp. But from the way he forecast the company's growth, you might have thought he was a key player on its strategic planning team. Banking on an educated hunch that the $1.5 billion software giant had hit pay dirt with its newly released revolutionary Windows operating system for personal computers, Wilson advised his New Freedom Investment Club to buy $742.75 worth of Microsoft stock. That was August 1990. Two years later, the investment has more than doubled in value. Up 126%, the stock is now worth $1,677.

Like most successful strategic investors, New Freedom strongly believes in using "insider's knowledge" to make investments. For New Freedom (named in honor of the long-awaited release of

Nelson Mandela from South African prisons in 1990), this philosophy means sticking to the industries that its 21 current members are familiar with, such as high-tech or health care. That's because, like Wilson, most of New Freedom's members work in Research Triangle Park, a high-technology business research center near Durham, N.C.

"Working in the high-tech field helped many of the members understand the significance of Window's initial popularity," says Wilson, a soft-spoken senior systems analyst at Glaxo Inc., a multinational pharmaceuticals manufacturer. As a result of this thinking, the 2-year-old club's portfolio (consisting of 12 securities worth $14,000) includes Apple Computers Inc., Glaxo Holdings (parent company of Glaxo Inc.) and Omnicare Inc, a Cincinnati-based pharmaceutical company.

New Freedom's investment home runs are unusual for such a young club, but its strategy is growing in popularity among small investors. Experts say that focusing on the stocks in your industry or about which you have some "insider's knowledge" increases the likelihood of investment success.

"The real big money is made by people who are in an industry and have the smarts to realize that something new is going to mean a company will be making more money down the road," says David J. Corcoran, president of York Securities Inc. in New York City. "Those people make the big scores."

This legal version of "insider trading" is only one of a host of strategies for beating Wail Street at its own game. Tracking the sale and purchase of a company's shares by its officers, directors and large shareholders can also forecast a stock's perfermance. Scouring trade newspapers and magazines for behind-the-scenes information about winners and losers can also give you the inside track. Investing in stocks with depressed prices because Wall Street has temporarily forgotten about them may also yield high gains. Finally, never forget to consider your own buying patterns and preferences. And successful investing isn't limited to stocks. Mutual funds can generate huge gains. They may specialize in an area that's suddenly hot, or they may be managed so shrewdly that they consistently outperform rivals. As interest rates have plunged in recent months, bonds have outperformed stocks. Even junk bonds, which most investors have shunned since the late 1980s, have rebounded since the beginning of 1991.

Here are eight common-sense ways to pick hot stocks on your own rather than depending on a broker. After all, many brokers are far more interested in generating commission income than in waiting patiently for your long-term strategy to bear fruit.

Buy What You Knew

Gail Perry-Mason, a financial adviser at Prudential Securities in Detroit, is knowledgeable about an array of investment products and services. But when it comes to investing her own money, she doesn't consider speculative strategies such as arbitrage--taking advantage of price disparities between markets by buying when the price is lower and selling when the price shoots up. Nor does she approach foreign markets like Japan. "I'm not very risky," she confesses.

But every few years when stocks in the financial services industry heat up, Mason, who also hosts the cable television show Detroit Business Exchange, starts watching. Then, when her own experience tells her business is getting better, she buys. "It's like when you go to buy a $35,000 car, and it's on sale for $30,000. Wouldn't you buy?"

If you have any reservations about sticking to what you know, just consider this: Microsoft is believed to be the only U.S. corporation with 500 millionaires and three billionaires among its work force. Likewise, Wal-Mart Stores Inc. made Sam M. Walton, its late founder, one of the wealthiest Americans throughout the 1980s and enriching thousands of clerks savvy enough to realize their own hard work contributed to a retailing revolution.

This strategy has worked well for New Freedom because Wilson and several other members are employed in the pharmaceuticals industry. Last year, the club invested $1,225.50 in Omnicare, which sells drugs to nursing homes and other health care facilities. In less than 12 months the investment shot up 62%, to $1,987.50.

Ordinary employees like construction workers recalled from a layoff, auto workers who see a second shift being added, or seamstresses whose sewing machines groan under a backlog of orders can all grasp their own industry as surely as any Wall Street expert.

Pepular Preducts Preduce Profits

Long before he opened his eponymous Wall Street investment firm, L.J. Altfest & Co. Inc., Lewis Altfest was scoring consistent investment home runs. His strategy was to invest in companies that produced products he was happy to purchase himself.

"I was a financial analyst at CBS Records back in 1968," he recalls, "and lhad one of those electro-mechanical calculators on my desk that would multiply figures if there wasn't a mallunction--but it would take a year and a day."

The apple of his eye was a machine in a different CBS department, about the size of today's personal computer. "It was called a Wang, and you just put the numbers in and out came the answer," Altfest says. "It turned out that there was a new [stock] issue coming out on Wang Laboratories, and I got some at the issue price." Before closing out his position in Wang Laboratories Inc., Altfest's $10,000 investment had quadrupled.

Peter Lynch's legendary investment in Sara Lee Corp., the manufacturer of L'eggs hosiery, produced a similar success story. The former manager of Fidelity Magellan, the world's largest mutual fund, learned about L'eggs from his wife. She loved the product, especially the fact that she could conveniently buy it at the supermarket. A number of women-only investment clubs have scored similar successes with Liz Claiborne Inc., now one of the nation's largest apparel companies. They sensed that the company's sensibly priced fashions for office and home would lead to growth.

To balance its portfolio, New Freedom has incorporated a few non-tech stocks. But still, the focus has been to "go with what you know." As the trend of corporate downsizing continues to drive up the ranks of executivesturned- entrepreneurs, the club is looking at firms like Office Depot. The Boca Raton, Fla.-based office equipment superstore chain caters to businesses of all sizes.

Likewise, New Freedom owns shares of Food Lion Inc., a Southern regional supermarket chain headquartered in Salisbury, N.C. "That's where we shop, so we're investing where we spend our money as well," Wilson says.

How do you learn more about companies that produce products or services that appeal to you and your friends? Once you've determined that the company is traded publicly, simply call. "Any company of substance has a shareholderrelations department, and it's free," notes Corcoran of York Securities. "If you're interested and want to put in a little time, you can find out all about the company at very little cost."

Request the company's annual report and the forms such as the 10=Q quarterly or 10K annual earnings reports, it is required to file with the Securities and Exchange Commission. Compare annual reports of other companies in the same industry before you decide where to invest.

Read The Trade Press Regularly

Investors can supplement their own knowledge of an industry, or learn about another, by reading the same trade publications that Wall Street analysts read. Readers of the trades look for information that will ultimately lead to gains or losses in corporate profits. Executive appointments can signal new corporate strategies. Products that ultimately could change a company's fortunes are announced in trade periodicals long before investors learn of them. Rumors of corporate reorganizations and acquisitions appear regularly in the trades, and when rumors become public knowledge, stocks can move significantly.

Through advertising, careful readers can even pick up clues that signal shifts in company business. Increased advertising may indicate that the company has a surplus of cash or desperately needs to generate cash. Advertising cutbacks could signal disenchantment with a particular product or other problems.

If you are considering ad stocks, you should read Advertising Age regularly. Womens Wear Daily is the bible of the fashion industry, and Variety lets you in on entertainment industry information that won't show up in the market (or in stock prices) for months.

"Stock analysts read the trades closely," notes Charles Cooper, executive editor of Computer Shopper, a trade magazine for individuals and companies interested in buying computers. "For the general investor, reading a trade magazine is one way of getting good original information. Then you can put the pieces together yourself."

Subscribe To Investment Newsletters

To supplement what is gleaned from the trade press, investors with a bit more money than time can subscribe to newsletters and let professionals do their stock prospecting for them. Big investment advisory companies such as Standard & Poor's Corp. and Value Line Inc., and individual stock pickers like Martin Zweig (Zweig Forecast, $265/yr, 800535-9649) and Louis Navellier (MPT Review, $245/yr, 702-8311396) have strong reputations for ferreting out undervalued investments. Mark Hulbert, whose Hulbert Financial Digest has tracked, profiled and reviewed a variety of investment letters for a dozen years, says these sources are particularly valuable because they "provide consistent follow-up advice for every stock they recommend."

However, Hulbert cautions that picking a winning newsletter can be just as difficult as picking a winning stock. "There's no easy answer to what's a good newsletter for any individual," he says. Many newsletters specialize in certain industries, while others chart technical market movements, rather than economic fundamentals or companies' performances. Still other newsletters track mutual funds instead of individual stocks.

Most newsletters will send samples on request. Publishers often offer brief, introductory subscriptions, making it possible for you to check out several newsletters at once. Hulbert's own newsletter, which evaluates 130 such newsletters, is a good place to start. The annual subscription is $135, but he offers a five-month trial for $37.50. (Call 703-683-5905.)

Move with the Insiders

The Securities and Exchange Commission requires corporate insider's top officers, directors and owners of more than 10% of a company's stock to report nearly all their stock trades. And while there can be any number of reasons insiders sell, in general there's only one reason they buy: They think the stock is headed up. "They're not going to put their own money on the line unless they think they can do extremely well," says adviser Altfest.

Periodicals like The Wall Street Journal and Barron's magazine report selected trades, but the only comprehensive source is Vickers Weekly Insider Report($112 a year; 516-4237710). It reports on corporate officers and directors who trade 500 or more shares within their companies at a price of $1 or more on the outside market. Vickers has a portfolio of current picks, based on particularly heavy insider purchases. When groups of insiders start purchasing more of their company's stock, it may be time to move with the group. Vickers picked the Coca-Cola Co. in September 1990, when its shares traded for less than $20; in mid-July, shares traded over $40.

Buy Stocks At Their Lows

Mason of Prudential Securities, who sometimes takes a contrarian investing policy, likes to buy the stocks everybody else sells. The key is to time your purchase when the stock has about reached the end of a downward cycle and repositions itself for a comeback. "You're really purchasing a stock when it's on sale," she says with a laugh.

Last December, awash in red ink because they couldn't move their iron, U.S. automakers were in Wall Street's doghouse. Brokers advised customers not to buy Chrysler, which was trading at $9, or General Motors, which was in the low $20s. But Mason didn't listen. Six months later, she notes, "Analysts were telling customers to buy Chrysler at $20 and GM in the $30s." As the car stock aged, consumers were forced to go out and buy new cars.

Similarly, bank stocks were deeply depressed in late 1990, even though interest rates were likely to fall as the nation suffered through a recession. When the rates did fall, bank earnings soared as they were able to borrow funds cheaply and lend them at higher rates. The banks benefited from the interest-rate spread and the average bank mutual fund shot up more than 60% in 1991.

investments other than stocks can be equally attractive if they're out of favor. High-risk, high-return junk bonds, all but forgotten after that market collapsed in the late 1980s, came roaring back in 1991. But this type of investment is best for investors with a great degree of personal knowledge about the junk bond in question or investors with a high tolerance for risk. Junk-bond mutual funds also may be worth a try. Three leading mutual funds--the IDS Extra Income Fund (800-3288300), Prudential High Yield Fund (800-225-1825) and T. Rowe Price: High Yield Fund (800-541-8365)--advanced 15% in the first half of this year.

Know Price Vs. Value

Investors should know that rising stock prices are not always good. Sometimes stock prices can rise too high, making it more likely that the stock will do nothing else but come down. "If a stock has gone from $2 to $20, you know you're not early on it," Corcoran counsels.

One way to find out if a stock has been "discovered" is to check the number of shares that institutions own. Big investors, such as pension funds and insurance companies, usually can buy shares in emerging companies before the general public. Various investment advisory services, such as CompuServe (a division of H&R Block Inc.), Telescan (based in Houston) and Value Line Inc. (New York City), keep track of institutional ownership.

Rely On Slow Growth

Wall Street watchers are almost unanimous on one point: The surest way to lose money is to try to be a market timer-- an investor who thinks he or she can catch price moves just ahead of the crowd. Says Jean-Marie Eveillard, portfolio manager of the SoGen International Fund: "I don't have a (pricequote) machine in my office .... We don't try to pick up moves in the markets of various countries. We are more interested in buying what we see as the cheap securities of good companies in established markets."

If investors try to react to every shift in the market, they will lose any possible gains in the costs of moving their stock. For example, individuals can spend $100 or more in commissions buying $2,000 or $3,000 worth of stock through a furl-service broker. Many popular mutual funds, such as Fidelity Magellan, charge a "load," or sales commission, of as much as 5%. Discount brokers can also tack on hefty fees; if you purchase $3,000 worth of a no-load mutual fund through your Charles Schwab IRA account, the fee is $30. You pay another $30 to sell it.

Most market gurus advise small investors to purchase investments as part of a long-term plan and then to stick with it.

Surely, armed with these tips, even novice investors don't have to be saddled with certificates of deposit that pay less than 4% annually. Create an investment strategy, stick with it, and you may indeed have many happy returns.
COPYRIGHT 1992 Earl G. Graves Publishing Co., Inc.
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Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Middleton, Timothy
Publication:Black Enterprise
Date:Oct 1, 1992
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