Choose Your Stocks with Selective Criteria

Physician's Money Digest, October 2005, Volume 12, Issue 14

Many times I have been asked what it is I am looking for when I choose individual stocks for a physician-investor's portfolio. Initially, I utilize a database to sort through all the exchange-listed stocks and use designated criteria to narrow down the universe of equities from which I choose. Some of the significant criteria I employ are the following: price/earnings (P/E) ratio; dividend yield; debt/asset ratio; current ratio; price/book (P/B) ratio; and return on equity (ROE).

•P/E ratio. This ratio is indicative of how many times a multiple of earnings a physician-investor is willing to pay for a firm's stock. Generally, I look for stocks that have low P/Es, which means that expectations concerning the future growth of the company's earnings are low. Consequently, if expectations are low, any earnings surprise generally bodes well for the firm's stock. As a benchmark for comparison, the average P/E for the stock market has been only 17 over the past 45 years.

•Dividend yield. Generally, a physician-investor's return is magnified when a stock pays a dividend. The dividend yield of a stock indicates the income generated by a particular share. Remember the old adage, "cash is king." Especially in the flat market we have been experiencing, a nice dividend- yielding stock is a blessing.

•Debt/asset ratio. This ratio, which shows the proportion of a company's assets financed through debt, measures the percentage of funds supplied by creditors of the firm. Generally, the smaller this ratio is, the better, as a lower debt/asset ratio implies a relatively small amount of corporate debt. Remember, that with more debt comes higher mandatory interest payments on the debt, which erodes profitability, earnings, and dividends on a per-share basis.

•Current ratio. A firm's liquidity or short-term solvency is measured by the relationship of its current assets divided by its current liabilities. Firms that have large amounts of cash and marketable securities generally have higher current ratios. This provides an added cushion for the firm to meet the claims of its short-term creditors should there be, for any reason, a downturn in their business. For example, a firm with a current ratio of 1.5 means that they have $1.50 of current assets to satisfy every $1.00 of short-term liabilities or obligations.

•P/B ratio. This ratio measures the relative relationship between a firm's stock price and the book value of its stock. Generally, this relationship indicates how a physician-investor regards the company. For instance, if the P/B ratio is 2, this means that physician-investors are willing to pay twice the book value of the stock for a share of the firm's stock. Again, I look for companies that have lower P/B ratios.

•ROE. This percentage tells a shareholder how much profit a company generates and measures the return on shareholder investment. For instance, if the return on equity is 15%, then the company is generating $0.15 in after-tax net earnings for each $1.00 of shareholder investment.

Let's examine a company that satisfies the above-referenced criteria: Altria, formerly the Philip Morris Company, ticker symbol MO.

Please keep in mind that criteria may vary dramatically by industry sector. For instance, you cannot compare the P/B ratio of the auto industry with that of the health care industry. Also, when examining measures, you want to pay close attention to how a firm in a particular industry compares with its peer group in general.

and his partner, Harris L.

Kerker, are principals of the Asset Planning

Group in Miami, Fla, specializing in investment,

retirement, and estate planning. Mr.

Kosky teaches corporate finance in the

Saturday Executive and Health Care Executive MBA Programs

at the University of Miami. He welcomes questions or comments

at 800-953-5508, or visit www.assetplanning.net.

Thomas R. Kosky