Strategies for Buying

Although nobody can be sure whether the stock market will go up or down over the next few months, you should aim to recognize the few really major, long term turning points in the market, such as the huge rebound that began in August 1982 and the crash of October 1987.

Stocks generally move in expectation of changes in the economy and in corporate profits. The market is always looking ahead. If both inflation and interest rates are heading down, that's bullish news. But when the consumer price index and interest rates on Treasury bills show sustained increases, watch out. It's a clear and present danger signal.

Fortunately, your own decisions about the stock market do not have to be perfect to be profitable. just watch for the major turns in the market. You can buy somewhere above the bottom and sell out some time after the market has hit its peak and still make more money than the investor who ignores the market's long term gyrations.

One old belief about the stock market is called the "efficient market theory." It holds that all new information about any stock spreads too quickly for ordinary investors to profit from the news before the stock rises. But that's not really so, according to a study by the Institutional Brokers Estimate System, a service of the brokerage firm Lynch Jones & Ryan. It found that after several stock market analysts sharply increase their earnings estimates for a company, its stock probably will do better than the major market averages for the next six months. In other words, you can benefit from good news.

Over nine years from March 1980 to March 1989, if you put money into the 20 stocks with the highest upward revisions of earnings estimates, and then sold them a year after you bought them, you would have earned 351/2% a year. That's far more than the 19% annual rise during the same period in the Standard & Poor's 500 stock index. The moral: It pays to shop around for stocks of companies on which several stock market analysts have recently increased their future earnings estimates.

At the other extreme, you also can do well buying stocks that recently have plunged as a result of disappointing earnings or oth er sour news. A number of them become good bargains. In fact, some of the shrewdest investment professionals study each day's stockmarket tables just to find shares that have hit new lows. They figure that if these stocks have intrinsic values, they may have nowhere to go but up.

If you decide to buy stocks, you must determine their basic values, as previously discussed. To help you gauge that, you would be wise to look at four measures:

Number one is the stock's historic trading range. You should consider buying on bad news when a stock nears its lowest price in the last three to five years. Number two is earnings. Look at how well a company has done in the last 10 years for an idea of what it is capable of earning. If the most recent results are at the low end of the range, ask a broker for his firm's estimate of earnings for the next six or 12 months. If a turnaround is expected, you may consider buying the stock.

Number three is book value per share. That is the company's net assets divided by the number of shares. If the stock is selling for less than book value per share, it may be underpriced and thus a good buy. If the price is less than half the book value, you have little to lose.

Number four is the balance sheet. Be suspicious of an unusually large amount of long term debt. The ratio of a firm's debt to the market value of its stocks should not be significantly above the average for its industry.

Once you have picked out some undervalued stocks, don't buy right away. It is axiomatic that turnarounds generally take longer to materialize than anyone expects. So spend some time watching those stocks. But also don't plan to wait until a stock hits its very bottom. Nobody is smart enough to pick that. Instead, set target prices, and buy if and when the stock reaches them. By doing that, you might do well buying bad news stocks.