Four Tips for Buying Stocks in Bad Times

November 13, 2008

Don’t Let This Buyer’s Market Pass You By!

I have to warn you to act quickly to take advantage of the current market conditions. In less than two months, the S&P 500 is off by over 30%. That’s giving us lots of bargains, and they won’t last much longer. The market is poised to rally before the end of the year as it often does. Despite this week’s sell-off, the market is still treading above its October 10th low. That’s a positive sign because it signals that we’re merely bouncing along and not falling through to a new low. There’s also over $3.5 trillion sitting on the sidelines ready to flood the market. Most importantly, the election is now behind us and with that uncertainty out of the way, more investors are looking to get back into the market.

In this week’s issue of What’s Working on Wall Street Now, I want to focus on how to invest during trying times. Specifically, I want to give you four tips on how to spot superior investments when the economy is weak. These tips will help you “look under the hood of your stocks,” and help you identify which stocks are promising stocks, and which ones you should avoid.

Return on Equity: A Sign of Efficiency

My first tip is to zero in on companies with high returns on equity (ROE). Return-on-equity is the gold standard of financial efficiency. This measurement tells us how much profit a company makes relative to what it owns. I like to think of ROE as a report card for a company’s management. I can’t always know what management is up to, but by analyzing a company’s ROE, it lets me know how prudent they’ve been with their shareholders’ money.  Management should never forget exactly who it is they’re working for. An ROE number above 15% is good, and anything above 25% is outstanding.

One company on my Blue Chip Growth Buy List that has a very high ROE is Gilead Sciences (GILD). Gilead is a biotech company that’s best known for its antiviral drugs that treat patients with HIV, hepatitis and influenza. Last year, Gilead made a net profit of just over $1.6 billion. But the company had an average equity of roughly $2.64 billion. If you divide the former by the latter, you get an ROE of 61%. That’s a phenomenal number—most companies would love to get half that much. We’re currently sitting on a 40% gain in Gilead in Blue Chip Growth, and thanks to its high ROE, Gilead continues to be one of my favorite biotech stocks.