Consistent Return On Equity Ratio (ROE) of 10 Percent

The ROE is another measure of management quality. This measure is not industry specific as a pre-tax profit margin. A well-managed company will have a consistent ROE of at least 10 percent over the last 5 years. A ROE of 15 percent is great. A ROE of less than 5 percent does not reflect well on management. This is a percentage that indicates how well common stockholders’ invested money is being used.

The percentage is the result of dividing net earnings by common stockholders' equity. Net earnings are the profits after all the costs of doing business have been subtracted from the money generated from sales. This is equivalent to your take home pay after all the taxes, social security, union dues, and so forth are subtracted from your base salary. shareholders’ equity is estimated and reported quarterly.

Where do you find the ROE? At Value Line or on financial websites such as www.smartmoney.com. This is an easy calculation to make; therefore, everyone reports the same number most of the time. Consider crosschecking any data you locate outside of Value Line.

Insiders hold 5 to 15 Percent (function of size and age)

Would you work harder if you owned a part of the company? I bet you would. Apply the same principle to your investments. The management team should own 5 to 15 percent of the company. There are exceptions to this rule and they should be viewed in context.

In general, insiders do not hold 15 percent of old large cap companies. Again, as with pre-tax profit margin, it would be logical to compare the insider holdings of similar companies operating in the same space. However, young small cap companies should hold at least 15 percent of the company. Small cap companies not owned by management are usually managed by the principal shareholder(s) (owners). They hire “puppet” managers to execute their demands. The owners manage from a distance. Investing in such a company is risky. Avoid investing in small- or mid-cap companies that are not managed by insiders.

How do you determine insider holdings? At Value Line or online financial websites. Insider holdings are easily obtained at www.siliconinvestor.com. On their homepage enter a ticker of the company your researching and click search. A quote will appear which will give current price, P/E, and other data. Click on the financials tab. Scroll down to the equity section. In this section you can determine insiders holdings and institutional ownership. Here is the equity section for Kohl’s (KSS):

Equity: Common Stock $.01 Par, 6/01, 800M auth., 334,385,719 issd.

Insiders own 15%. Three others own 27%. IPO 5/92, 9.675M shs. @ $14 by

Morgan Stanley (MS). PO 3/94, 4.9M shs (1.1M by Co.) @ $50.875 by MS.

PO 8/97, 4.6M shs (3.9M by Co.) @ $63.8125 by MS.

Insiders control 15 percent of Kohl’s common stock. Such a high insider holding is uncommon for a large-cap company, however, Kohl’s is fairly young (IPO 5/92).

As you can see, large cap companies might have high insider holdings. There are no rules to the percentage insiders should hold with the exception of small-cap and mid-cap companies (insiders should own at least 15 percent).

Diversified Product Line

Products come and go in a relatively short time cycle. Good management will weather these cycles to ensure sustained growth over the long run. Companies must react to an environment that is constantly changing. Ask the following question: “Has management consistently produced new and exciting products over the last five years?”

Producing new products is time-consuming and money-intensive. Therefore, a good management team will commit itself to a strong research and development program to ensure they are constantly ahead of the competition. Companies that have one product are risky investments. Invest in companies that have a habit of developing new well-accepted products. Invest in managers that sell and create excellent products.

Product information is easily found online at the company’s website or online financial sites.