Y IS THE NEW ECONOMY
THERE ARE ONLY TWO REASONS A STOCK GOES UP
As near as I can tell, there are only two reasons for a stock to advance.The ﬁrst is that the company gains some type of popularity or notoriety.This is fodder for reports and stories of new prospects, potential gains.People  love  new  things,  love  innovations;  investors  are  always  lookingfor  the  newest  innovation  in  the  marketplace  on  the  assumption  that it will drive prices higher. Stocks have rotated over the years. One yearthe drug stocks were in vogue and simply couldn’t go down. That wasuntil another group of stocks, the biogenetic ones, became the darlingsof  the  day,  which  gave  way  to  computer  chip  manufacturers.  And  so it  continues;  there’s  always  one  group  of  stocks  that  just  caught  in-vestors’ fancy.
These  stocks  go  up  because  of  stories  and  rumors  and  possibly  evensome form of manipulation, which is not out of question in a free marketsystem.  When  people  are  long  stocks  it  is  only  natural  for  them  to  wantprices to go higher. Some people just may want to see if they can be part ofthat  program  through  a  campaign  of  positive  publicity,  which  may  evendeteriorate into out-and-out touting. Trust me, it happens. I’ve seen it—ittakes place. I know it is not supposed to, but it does. There are even legalforms of this, after all, corporations can run ads, and investors can havetheir brokers call up suggesting you and I purchase stocks based on the sto-ries they spin. Brokers would make good politicians, as they are wonderfulspin doctors.
Everyone  seeks  the  same  outcome;  then  at  some  point,  higher  pricesthemselves become what is driving the stock higher. A feeding frenzy hasbegun. The beast feeds upon itself! To the surprise of classical economists,higher prices, which are supposed to deter or decrease demand, have in ac-tuality increased demand. Computer bells have sounded the alarm; the gar-gantuan  momentum  or  up  move  appears  to  be  precisely  a  promise  ofproﬁtable performance for the coming good years. Sometimes that scenarioworks out, at least for a while, but most often what runs up like a balloonfull of hot air falls once investors’ attention is turned in another directionor some pundit bursts the balloon.
That’s  why  stocks  such  as  Priceline.com  could  rally  from  $10  ashare  to  $105  a  share  and  back  down  to  $5  a  share,  and  all  in  less than 15 months. This stock is not an exception—I have seen it happentime  and  time  again.  Which  means  it  will  happen  in  the  future,  manymore times.
CCC-Williams 2 (67-144).qxp 4/24/03 6:54 AM Page 109
HOW TO BUY STOCKS AT A “DISCOUNT”
109
News stories and/or the great myth of a revolutionary new product ormarket  have  driven  up  the  price  of  a  stock.  You  should  never  underesti-mate the ability of news and greed to drive prices higher.
THE SECOND REASON STOCKS ADVANCE
The second reason stocks go up, and certainly the more stable one, is be-cause the company is making money. What a novel concept this is: Makemoney and the price of the stock goes higher! There are several ways oflooking at earnings ratios and that sort of thing, but one of the most sig-niﬁcant ways I think of using them is to see whether the earnings are er-ratic or consistent. I’m certain you have ﬁgured it out; investors wouldprefer consistency that eliminates questions and fear of the future. Themarket hates the unknown; it hates anything that is unreliable. So an er-ratic pattern of earnings may occur in a stock that has a short-term rally,but this is not where serious and consistent (as well as easy) money is tobe made.
As earnings go, so go the prices of stocks. That is our mantra, now andforever. You can have your choice: Buy stocks that go up on the whims ofnews and stories or ones that go up based on actual conditions.
It’s your choice: news or value? I have chosen value, as you will see.The mantra of value can become a most valuable tool in helping us makeour  individual  stock  market  selections.  The  all-time  great  long-termgrowth  stocks  maintained  their  price  advances,  in  just  about  every  in-stance, only during times when they were consistently proﬁtable and werebecoming more so every single quarter.
The  great  stocks  of  the  past,  when  they  did  collapse,  clearly  startedtheir declines about the time their earnings started to decline. Thus, this isone of the most important facets of investing, one of the best indicators wecan follow.
HOW TO BUY STOCKS AT A “DISCOUNT”
Because of stories, rumors, news, and overall market conditions, even goodstocks, those with consistent increases in earnings, can and do go down. Ihave determined a rather unique way of telling when it is best to purchasethese stocks when they are at what I would call a “discount.”
CCC-Williams 2 (67-144).qxp 4/24/03 6:54 AM Page 110
110
THE OLD ECONOMY IS THE NEW ECONOMY
The discount I’m talking about is the discount in relation to their earn-ings.  The  pattern  we  will  be  looking  for  is  one  of  consistent  increases  inearnings—which  means  that  the  current  12  months  earnings  number  isgreater  than  that  reported  at  the  accounting  period  three  months  earlier.What’s  going  on  here  is  the  company  is  still  making  money  and  still  in-creasing its earnings growth. That’s good.
However,  for  one  reason  or  another—usually  overall  market  condi-tions, I should point out—the price of the stock enters a declining phase.The  farther  the  stock  declines,  the  more  it  approaches  being  at  a  “dis-count,” if you will, to the trend of its earnings.
What’s going on here is that while prices of the stock have been declin-ing,  the  overall  conditions  of  the  company  have  been  improving,  as  evi-denced by an increase in earnings. This is a very positive divergence: pricedown, earnings up. Unfortunately, this condition doesn’t occur very oftenin the life of a stock; but when it does it usually marks one of the most op-portune times to step in and buy, and buy in the face of price weakness!
I’m showing several examples so you can see for yourself how powerfulthis technique is. All the following show price action versus earnings. Youcan see this technique in action in almost any charting service that showsearnings as well as price action. I strongly suggest you subscribe to a ﬁnan-cial  newspaper  so  that  you  can  get  a  feel  for  this  technique  of  locatingstocks that are undervalued in relation to their earnings growth. Financialnewspapers frequently print charts of stocks and their earnings. While mostinvestors look at all sorts of things, ratios and the like, I simply want to ﬁnda stock that is priced lower this quarter than the prior quarter. The key isthat at the same time earnings are higher this quarter than the prior quarter.Such a pattern of divergence sets up our buy signal. You can enter sim-ply at the end of the quarter, or, if one wanted to play things a little closerto  the  vest,  perhaps  have  a  buy  order  slightly  above  the  market  price  tomake certain the trend has turned up.
Harley-Davidson
Harley-Davidson has been one of the premier growth stocks, and there’s anobvious  reason  why.  Check  out  the  earnings  trend  shown  in  Figure  8.1.Quarter  after  quarter,  year  after  year,  the  company  has  managed  to  in-crease its earnings per share. This is the ideal scenario investors should see.The company is almost impervious to downturns in its earnings. They haveconsistently done better—what a great sign that is to long-term investors!
CCC-Williams 2 (67-144).qxp 4/24/03 6:54 AM Page 111
HOW TO BUY STOCKS AT A “DISCOUNT”
111
Figure 8.1 Harley-Davidson
But notice the price of the stock does not necessarily travel in a straightline upward. Indeed, look at what happened in 1999: Prices stalled out atthe $32 share level, dipping down to $23 a share. Or how about the wildride in the third quarter of 1998 when prices went from $20 to $13? I’ll betthat  scared  most  of  the  riders  of  this  stock  off  their  Harley  “hogs.”  We,however, would have seen it differently. We would have noticed that at thesame time earnings were better at the end of the third quarter of the yeardespite the decline in stock prices, just as they had been at the end of thelast quarter in 1997. Prices had declined from approximately $16 a shareto $12 a share, setting up the buy signal, and away went Harley. The nextpoint  to  be  a  buyer  of  the  stock  was  on  the  decline  into  the  start  of  thefourth quarter in 1998.
The  increase  in  earnings  while  the  stock  was  declining  was  a  give-away  as  an  indication  of  higher  prices  to  come.  The  next  time  this  oc-curred  was  in  June  1999  when  prices  were  marginally  lower  for  thequarter.  The  price  of  Harley  didn’t  do  much  following  this  juncture.However, the same scenario developed at the start of the last quarter of1999,  when  again  prices  got  slammed  down  but  earnings  continuedchurning  forward.  That  was  your  fourth  opportunity  to  buy  the  stock,this time at about $24 a share.
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 112
112
THE OLD ECONOMY IS THE NEW ECONOMY
That began a move taking the stock to $46 a share before the priceagain  got  slammed,  declining  from  $50  a  share  back  down  to  the  $35zone.  But  once  more,  our  handy  dandy  internal  view  of  market  condi-tions, earnings, was still in a positive up trend, suggesting the stock couldbe purchased at a discount. After all, prices were down and earnings wereup. That buy signal at $34 looked pretty good, as prices had moved above$50 a share since. The start of the third quarter in 2001 looked like a buypoint  as  the  price  of  the  stock  had  been  ﬂat  if  not  down,  yet  earningsagain continued to be higher, suggesting the stock was undervalued in the$36 a share area.
Federal Home Loan
It’s a long step from motorcycles to mortgage companies. Their corporateenterprises  have  precious  little,  if  anything,  in  common.  But  when  itcomes to investor interest, the same thing continues to work when earn-ings  are  increasing  and  the  price  of  the  stock  is  down.  Historically,  thestock has been a buy. The ﬁrst setup we see in Figure 8.2 was in the Sep-tember  1998  time.  The  price  declined  for  the  quarter  yet  earnings  werehigher than the prior quarter. The stock rallied. Buy signals continued to
Figure 8.2 Federal Home Loan
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 113
HOW TO BUY STOCKS AT A “DISCOUNT”
113
develop as I’ve marked on the chart in September 1999, December 1999,March  2000,  and  as  well  as  June  2000.  Your  average  cost  would  havebeen  approximately  $46  a  share.  It  was  not  until  September  2000  themarket seemed to notice this discrepancy or discount. Keep in mind thatthe reward of value may be delayed but it is never denied. A year later youcould  have  cashed  out  almost  doubling  your  money  as  the  stock  begantrading near $70 a share.
It was such an obvious play; consecutive increases in earnings are ex-tremely  positive  to  the  long-term  trend  of  individual  stocks.  Traders  andinvestors may not notice this for a while, which is why we want to care-fully follow this earnings-to-price relationship. But at some point the dambreaks and the price moves higher.
Hillenbrand Industries
There are countless examples of this discount buying opportunity develop-ing in stock after stock. I chose one at random here in a company I knownothing about, Hillenbrand Industries. If we studied just the price action ofthis stock from 1984 into 1998 (see Figure 8.3) we might suspect it wasone  of  the  computer  or  new  economy  issues.  But  it’s  not.  Hillenbrand  is
Figure 8.3 Hillenbrand Industries
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 114
114
THE OLD ECONOMY IS THE NEW ECONOMY
primarily engaged in funeral services. See, you don’t have to be involved inhigh tech to make money.
Notice  how  consistently  the  price  mirrored  earnings.  As  earnings  in-
crease, the price increases. That is the law of the Wall Street jungle.
But along the way, at times, the price has declined. Notably, look at thedecline  in  the  fall  of  1987.  Look  as  well  at  what  earnings  were  doing,though; they were increasing, telling us that the stock was a buy in the $10area. Earnings were slightly higher in 1990, while the last two quarters ofthat year saw prices declining. This again sets up our discount buying op-portunity. In 1993 an investor would not have done quite so well, as earn-ings went higher while the price went lower, thus setting up a buy point inthe $40 a share area. No rally sprang up, but as long as earnings were go-ing higher we would know we were getting the stock at a discount. Thiscondition—increased  earnings  as  lower  prices  continued  into  1994  whenthe stock bottomed at $26 a share, still giving our discount bottom buy sig-nal—may well be one of the reasons the stock zoomed up to $64 a share,more than doubling in the next to 18 months.
Again, a discount buying opportunity was presented. Earnings contin-ued going up during time periods when the stock price went down. Eachand every example of this discount buying opportunity would have mademoney for the savvy investor.
Carlisle Companies
Here is another one of those nondescript companies, not much glamourto it. Carlisle is a holding company with interests in automotive, indus-trial, and construction materials. Yet look what the price did (see Figure8.4). It went from $6 to $50 a share. Again, there’s no need to get car-ried away with the new economy. The old economy, thank you, has donevery well.
An  investor  following  this  issue  would  have  noticed  that  as  it  brokeout in 1992 to the upside it was in some type of uptrend. Prices did notbreak out of the 1984 to 1992 base because of the chart. No, prices brokeout because earnings broke out to the upside as the company began sevenyears of consecutive increases in its annualized earnings reports.
In 1994 earnings substantially increased yet the price moved sidewaysin the $16 zone. This presented us with a discount buying opportunity—price ﬂat, earnings up. Guess what else. It was 1994—right in phase withour four-year phenomenon, which led, in this case, to a decennial pattern
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 115
HOW TO BUY STOCKS AT A “DISCOUNT”
115
Figure 8.4 Carlisle Companies
ﬁve year, when one usually sees bull markets. The stock responded in stel-lar fashion, continuing to rally.
In the ﬁrst quarter of 1996 there was another discount buying oppor-tunity as well as one in the second quarter of 1997 that set up a buy pointin the $27 range. Astute investors purchasing at this time period because ofthe discount scenario were quickly rewarded with an increase of prices toover $50 a share.
Chartists and technicians spend their entire lives looking at price struc-tures trying to divine in some fashion what the future might be. What a fu-tile  experience,  what  a  waste  of  time!  Charts  are  next  to  impossible  toread,  daily  or  weekly  price  action  are  a  mumbo  jumbo  of  chickenlikescratches on paper.
The signiﬁcance of price charts comes not from looking at prices butfrom  looking  at  what  causes  prices  to  move,  which  is,  by  and  large,earnings.
Thompson Corp.
Let’s now turn our attention to Thompson Corp., a publishing company oftravel  and  ﬁnancial-related  materials.  While  our  chartist  and  technician
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 116
116
THE OLD ECONOMY IS THE NEW ECONOMY
friends look at price, we are interested in earnings. It takes no more than aglance at Figure 8.5 to see that this company has had an erratic earningshistory  and  has  not  been  able  to  consistently  make  money.  Does  a  stocklike this excite us? No way! Turn the page, hang up on your broker, cancelyour subscription to the newsletter that recommends stocks like this. Sure,it had a nice price move from $12 all the way to $30, but stocks like thiscan  crash  just  as  easily  as  they  rally.  The  inconsistency  of  earnings  is  akiller. It is far easier and more secure to invest in companies that have con-sistently made money than to fool around with stocks that move becauseof the unexplained.
Always keep in mind that charts do not move the market’s conditions;fundamental conditions move the market the majority of the time and witha great deal more consistency than technical gibberish.
GOING BEYOND EARNINGS: COMPANY DEBT
Earnings are not the only thing I pay attention to but they certainly are themost dominant focus. Later on we will get to things like dividends, yields,
Figure 8.5 Thompson Corp.
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 117
GOING BEYOND EARNINGS: COMPANY DEBT
117
and  the  all-important  price-to-sales  ratios.  But  before  we  get  there,  let’stalk  about  two  other  important  considerations  that  help  us  select  greatstocks: company debt and insider buying and selling.
When I look at the balance sheet of a company, in addition to its earn-ings  I  am  very  interested  in  looking  at  the  amount  of  debt  the  companyhas. I do not like debt; I do not like it in my life, and I don’t like it in cor-porate life. I’ve been in debt, and I’ve been out of debt. Being out is far bet-ter, I assure you.
There  two  problems  with  debt:  On  a  personal  basis  it  is  simply the pressure it places on us. Can you imagine what is like to be a corpo-rate  CEO  knowing  you  are  on  the  hook,  or  the  company  is,  for  hun-dreds of millions of dollars? I suggest a CEO in that scenario is not asﬂexible,  or  creative,  or  productive  as  the  CEO  who  doesn’t  owe  onepenny to the bankers.
So, one CEO is simply better off psychologically than the other. If youbelieve, as I do, much of our success in life starts from our belief system orour attitude, this is a tremendously important consideration. I’m convincedsome CEOs have so much debt that they just can’t envision ever liquidatingit, so they, and their companies, simply muddle along paying the piper andgetting noplace.
The inherent problem with debt has to do with a poor economy. As weknow, the stock market is not a straight road up; it also goes down. It usu-ally  goes  down  when  interest  rates  go  higher.  What  stocks  do  you  thinkwill go down most when interest rates go higher?
Obviously,  stocks  of  companies  that  have  substantial  debt  will  godown most, simply because the corporations must now pay a greater per-centage of their income to the bankers. This doesn’t leave them funds leftover to expand their companies and/or pay dividends to shareholders.
Not  only  does  this  place  restrictions  on  the  companies,  but  it  placesfurther psychological pressures on those running these high-rolling outﬁts.The CEOs have no choice but to pay the bankers, because if they don’t paythe  ﬁnancial  institutions,  the  loans  are  called  in,  and  the  prices  of  thestocks suffer even more. So the ﬁrst allegiance is not to shareholders, nor isthe  ﬁrst  allegiance  to  the  companies  themselves,  which  could  use  thatmoney  to  further  promote  their  products  and/or  expand  their  operationand research abilities. The bankers come ﬁrst.
Our second mantra of investing is “stay away from high-debt compa-nies.”  Buy  low  debt/no  debt  companies.  When  the  times  get  tough  those
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 118
118
THE OLD ECONOMY IS THE NEW ECONOMY
guys  don’t  get  beaten  up  nearly  as  much  as  the  highballing,  high  debtpuffed up companies.
WOULD YOU EAT THERE? INSIDER BUYING AND SELLING
Let’s  forget  about  stock  investing  for  moment  and  talk  about  food.  Let’stalk about eating in a very nice restaurant, perhaps the nicest one in town.If you saw the owners of that restaurant taking their meals, on a daily ba-sis, at the restaurant across the street, what would you think? Would youthink something was wrong? The people who own a restaurant are afraidto eat at their own place?
I would! It is no different when it comes to the world of ﬁnance. Oneof the better long-term indicators of potential growth in a company comesfrom  monitoring  the  purchases  and  sales  of  the  stock  of  the  people  whowork  at  the  company.  It  makes  ultimate  sense;  if  the  people  who  workthere are buying stock in the company it most likely is going to rally. Theybelieve in the company, believe in it so much they are plunking down theirhard-earned cash.
The other side of this issue is if the people who work there are sellingtheir stock, getting out of the market, one just might suspect there’s a rea-son for this. Now, what could that reason be? And who would know betterif the stock was going up or down than the people who work there?
One  of  the  realities  of  the  marketplace  is  that  insiders  have  an  ex-tremely good record of getting out of their companies the right time andbuying into their companies the right time. One of the best all-time tradesin the history of mankind was that by Bill Gates.
People give Gates all sorts of credit for being a computer whiz kid andan iconoclastic, positively brilliant businessman. They see him as the typeof genius who has visions of a future that we have not yet begun to grasp.All that could be so, but it is not what impresses me most. What impressesme most about Bill Gates is that he had the foresight to sell thousands andthousands  and  thousands  of  shares  of  his  Microsoft  stock  when  it  wastrading at about $100 a share, just before it plunged to $40 a share. He isthe  best  trader  in  history,  making  hundreds  of  millions  upon  millions  ofdollars of real proﬁts based on his timely selling.
The numbers of his trade were staggering (see Figure 8.6). On Febru-ary 22, 2000, he liquidated 2.9 million shares. His good buddy, Paul Allen,who had began selling off Microsoft in the fall of 1999, sold 164 million
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 119
WOULD YOU EAT THERE? INSIDER BUYING AND SELLING
119
Figure 8.6 Microsoft Corporation 1999–2001
shares on February 11, 2000. When one looks at their activity at this timeit appears they spent more time with their brokers to liquidate stocks thanwith corporate activity. They just sold and sold!
In some fashion, and for some reason, whatever that was, they got outof the market just before the big slide began. Smart guys do smart things.The  owners  of  companies,  especially  the  size  of  Microsoft,  are  smart.When they do things they are most likely to be correct, and history showsit behooves us to follow their action.
An  insight  here  into  insider  buying  and  selling  is  that  if  just  one  in-vestor in the company is buying or selling, it is not nearly as signiﬁcant as ifa  group  of  the  insiders  is  purchasing  or  selling.  Any  one  individual  mayneed to sell stock for tax purposes, to buy a new house, or whatever. Butwhen a cluster of these people start liquidating their stocks it’s a safe betthey’re not all buying a new house. They all have probably seen some rea-son to take such action. The more insider buying and selling at a speciﬁctime, the stronger the message is.
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 120
120
THE OLD ECONOMY IS THE NEW ECONOMY
Also, of course, the amount of stock they are selling is signiﬁcant; aninsider  selling  100  shares  is  not  as  negative  as  an  insider  selling  1,000shares.  Insiders  are  required  to  report  to  the  Securities  and  ExchangeCommission all of their activity by the 10th of the month following thetime they bought or sold. Sometimes these insiders will delay their pur-chase or sales the maximum amount of time to just get under the ﬁlingrequirement.
The level of insider selling almost always exceeds that of insider buy-ing, so we need to monitor the selling in light of the fact many corporateexecutives are compensated by stock as well as salaries. Generally speak-ing, there are about 2.5 shares of insider selling for every share of insiderbuying. Looking at that ratio may help you understand what is going on inthe companies you are interested in. 
Fortunately, we can track insider buying and selling activity for freeon the Internet. My favorite web site is www.insiderreview.com. There isas much information as one could possibly want about insider transac-tions on this web site. You can select the stock of your choice with theticker symbol or review all stocks that have been purchased and sold byinsiders.  There  is  also  a  tabulation  of  insider  activity  speciﬁcally  de-signed to show you where the majority of buying and selling is currentlybeing done.
Additionally, the web site offers the ability to follow the insiders whohave the best record of buying and selling to give us further focus and helpus use this approach to trading or investing. There are literally thousandsof pages ﬁled on a daily basis with the Securities and Exchange Commis-sion, far more than you and I could ever go through, so it is simply won-derful to have all this information available at the click of a mouse.
Once you have found the stocks you are interested in, you may ﬁlterthem out with some of my techniques, or perhaps screens from other au-thors or of your own making. I would suggest you go to the web site just tomake certain insiders have not been dumping the stock you want to pur-chase. Hopefully, you will see they have been big buyers, or you may spot adifferent stock where insiders have been large accumulators. Good! Thencheck out its earnings, and so forth.
Let’s review our big three fundamental guns to begin our search for greatgrowth stocks. First we want to pay attention to earnings. We will pass onany company that is not making money and/or not doing it in a consistent
CCC-Williams 2 (67-144).qxp 4/24/03 6:55 AM Page 121
WOULD YOU EAT THERE? INSIDER BUYING AND SELLING
121
fashion. We’ll follow the money—show us that money is being earned andwe will consider investing.
Then we’ll run a background check on our potential investments to seewhat  type  of  ﬁnancial  shape  they  are  in.  If  they  have  a  lot  of  debt,  nothanks! Finally, if people who work there have been consistently selling offhuge quantities of company stock they own, no thanks!
Yes,  there  is