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You might say Kenneth Johnson has a philosophy that’s in step with this era of alleged UFO cover-ups, White House prosecutor Kenneth Starr and X-Files paranoia: trust no one. And while Johnson, who runs a couple of portfolios for the St. Louis money management firm Investment Counselors Inc., isn’t planning to demand a nationwide inquiry soon, he says the numbers corporations release to you and me tell only so much.
What Johnson, 31, has noticed in his six years of investing funds for such clients as Consolidated Paper Co. and the St. Louis City Employees retirement pension is that accountants can doctor corporate earnings figures and revenues any number of ways to make the bosses look good. “Earnings figures help,” he notes, “but we’ve found that scratching past that and getting down to cash flow growth is how we really see how things are going.”
Investment Counselors’ approach to peeling away inventories and amortizations can get sticky for average investors, even if they’ve helped the firm rack up an average annual return of 26% over the last three years compared to 22% for the Russell 2000. Still, there are ways for the humble armchair investor to put some of his or her practices into play. Johnson limits himself to companies that have been public for at least three years. “It takes time to get used to being accountable to shareholders,” he says. “It’s quite a job to meet quarter-to-quarter goals and keep the public happy.”
Then, it’s important to see how many shares management owns. Johnson’s encouraged to see 25%-30% of a company’s outstanding stock held by the same people who supervise day-to-day operations. “It certainly shows that the people in charge have to care about profitability,” he says. Another screening tip, he says, is to weed out any company with a debt load greater than 30% of its capital. And finally, borrowing the words of famed investor Warren Buffet, get ready to buy and hold. “We typically own a stock two to three years,” says Johnson. “If you aim for less, you’re essentially speculating and trying to time the market, which on occasion brings short-term success but doesn’t always hold out for the long haul.”
That’s not to say Johnson is playing it strictly conventional these days. Echoing the sentiment of many managers who’ve recently appeared on these pages, he says large corporations are looking a bit pricey. Even though the S&P 500 has had an annual gain of over 30% the last three years, he believes the time has come for small and midcap stocks to strut their stuff. “Since valuations for large caps are so high, there’s a lot more risk in that segment of the market,” he says. His solution: look for smaller companies with higher growth and lower price-to-earnings (P/E) ratios.
Chart Industries (NYSE: CTI) is a stock that clears Johnson’s long row of hurdles. The fact that the company, which makes and transports specialized gases used in the production of metals, is slated to expand earnings at a