Page 476 - How to Make Money in Stocks Trilogy

346 INVESTING LIKE A PROFESSIONAL

that’s begun to build steam. It’s the “steam” (earnings, sales, and price and
volume strength) that is the key prerequisite for future growth. Don’t be
fooled by bargain-basement thinking or buy stocks on the way down
because they look cheap. Replace your hopes and fallible personal opinions
with proven, measurable facts.
It’s also interesting to note that these practical, no-nonsense ratings have
helped to wake up corporate board members and put pressure on manage-
ment teams producing second-rate results. A consistently low IBD relative
performance rating should be a serious wake-up call to any top management
team or board of directors.

Strong Sales, Profit Margins, and Return on Equity Are a Big Clue
Cutting costs may boost a company’s earnings for a quarter or two, but pow-
erful, sustained profit increases require healthy sales growth. It’s also impor-
tant to buy companies that make the most of their sales growth. How much
profit do they generate from each dollar of sales? How well do they use their
®
capital? The Sales + Profit Margins + Return on Equity (SMR ) rating com-
bines these important fundamental factors and is the fastest way to identify
truly outstanding companies with real sales growth and profitability. These
are factors that are widely followed by the better analysts and portfolio man-
agers. The SMR rating is on an A to E scale, with A and B being the best. In
most cases, you want to avoid stocks with an SMR rating of D or E. See the
column labeled 3 on the chart on page 342.
Example: An SMR rating of A puts a stock in the top 20% of companies in
terms of sales growth, profitability, and return on equity. During the brief rally
that followed the Nasdaq’s bear market plunge from March to May 2000, SDL
Inc. shot ahead as a leading performer. The maker of components for fiber-
optic networks broke out to new highs just as the market confirmed a new
uptrend, the most ideal situation for buying a stock. SDL Inc. ran up 112% in
just eight weeks. Among its many strong qualities was an SMR rating of A.
For those who may not have always checked your stocks’ return on equity,
it’s important. The table on page 347 of past leaders shows their ROEs.

Accumulation/Distribution—The Influence of Professional Trading on Stocks
Professional investors wield a huge amount of influence over a stock’s price.
Thus, it’s essential that you buy the better stocks that mutual funds are buy-
ing and that you sell or avoid the ones they may be selling on a heavy basis.
Trying to go against this monumental amount of trading will only hurt your
results. A quick, efficient way to keep track of the end result of professional
trading is to use IBD’s Accumulation/Distribution Rating (the column
labeled 4 on the chart on page 342), which is based on daily price and vol-