Not having learned,
many investors are still
running after ‘hot’ stocks

NEW YORK >> Even as market experts forecast modest returns for 2005, investors have snapped up shares of stocks that appear overvalued -- a troubling sign that suggests people are pinning their hopes on short-term momentum instead of long-term fundamentals.

The broader market sagged during the year's first two weeks of trading, but even on days when the major indexes were weak, investors showed great interest in stocks like Sirius Satellite Radio Inc., Taser International Inc. and other issues with questionable potential. The fact that so many are so excited about companies offering so little makes some more conservative analysts nervous about a rise in speculation.

"The momentum monkeys are back. 'It's going up? Let's buy it,"' said Jeffrey D. Saut, chief investment strategist at Raymond James & Associates. "This is very reminiscent of what was going on in some of the bubble years. Most people have not accepted the fact that we're in a low-return environment."

Saut considers Sirius, Taser and other issues that have developed strong followings despite minimal earnings, or even losses, to be "cult stocks." Since their gains are driven by momentum, these stocks tend to be quite volatile. Shares of Sirius, which needs to quadruple its subscribers to become profitable, were trading around $2 during the August lows, surged to more than $9 last month, and are now hovering near $6.50 -- despite the company's lack of earnings.

Taser, which does have positive earnings, has also gyrated, from an August low of less than $13 per share to a Dec. 30 high of $32.59. Now the subject of an informal inquiry by the Securities and Exchange Commission regarding the safety of its stun guns and the timing of a recent distribution deal, it is trading for just under $20.

As of yesterday's close, the Nasdaq was down more than 4 percent since the start of the year, the Philadelphia Semiconductor Index has shed nearly 7 percent. Yet fear in the marketplace, as measured by the Chicago Board of Options volatility index, or the VIX, has remained at lows not seen since the mid-1990s.

"It's like whistling by a damn graveyard," Saut said. "You've got rising inflation, waning economic momentum, waning earnings momentum ... I feel like I'm from a different planet. How can we all eat at the same table and then disagree about what's been served? I look at some of this stuff, and the valuations make no sense to me."

When droves of investors seem to be following a "buy high and sell higher" theory of investing, it's difficult not to get swept up in the excitement, said Ken Janke, chairman of the National Association of Investors Corp. But if you're a long-term investor, leaping in on a fad is almost always a mistake.

"There is probably always room for some speculative stocks on the market," Janke said. "But it scares me. I don't want any percentage of large investments in my own portfolio in those stocks. I want ones with proven growth records and good managements in place."

For the individual investor, Janke's organization offers guidelines to help people invest successfully in stocks by using fundamental analysis, by looking at the history of the company and its potential for growth, focusing on both management and price. For a stock to pass this test, it should have consistently growing or steady revenues; it should be efficient enough that its growth is reflected in its earnings-per-share, which is the bottom line for shareholders; and pre-tax profits should be consistent and compare favorably to other companies in its industry. In addition, investors should look closely at the percentage earned on investment capital -- the amount of money left in the company -- and make sure it's used appropriately.

Then it's a matter of determining whether the company's share price appears fair compared to its earnings, or potential for earnings.

The most widely used measure for valuation is the price-to-earnings ratio -- which is equal to a stock's market capitalization divided by its after-tax earnings over the last 12 months. The higher the P/E ratio, or earnings multiple, the more the market is willing to pay. NAIC suggests investors look for stocks that are selling at or below the average P/E ratio for the last five years. You should also compare it to the market and companies within the same industry. Companies that are not profitable, like Sirius, don't have P/E ratios. Taser has a P/E of more than 70 -- higher than its industry average of 50, and significantly above the Standard & Poor's average P/E of 23.2.