A valuation gap still exists between U.S. and non-U.S stocks. Relative to ten years ago, for example, the S&P 500 ‘s price has appreciated 92% versus 21% for Morgan Stanley Capital International’s EAFE index of stocks from developed economies in Europe, Australasia and the Far East.

Could that gap close? As the euro’s recent rise might suggest, there’s evidence of a growing appetite for non-U.S. financial assets. And it ‘s not hard to argue that U.S. stocks have plenty of room to fall. Based on reported earnings, the S&P 500 now has a trailing 12-month price-to-earnings ratio (P/E) of 29. In early 1995, as the last bull market began its climb, that ratio stood at 16. Hardcore bears say that even the multiple from 1995 looks too rich, arguing that down markets usually don’t grind to a halt until earnings multiples bottom out in the single digits.

The bears could always be wrong, but it still may be prudent to make a couple of bets on non-U.S. stocks. For U.S. investors, American Depositary Receipts (ADRs) are the easiest way to do so.

Listed on American exchanges, ADRs are certificates issued by U.S. banks acting as the depositary for shares in the non-U.S. companies. They provide American investors with the same economic benefits as regular shareholders, including dividends.

Example: Cadbury Schweppes. At a recent $23, ADRs for the London-based beverage and candy concern trade at just nine times trailing earnings per share. That looks very reasonable next to PepsiCo’s trailing multiple of 23. Coca-Cola sells for 24 times trailing profits. And compared to its U.S. rivals, Cadbury shares are also cheaper relative to book value and sales.

Full story at Forbes.com

From tulips to internet stocks, hot sectors have a long history of bringing misfortune to investors. But James Floyd, co-portfolio manager of the Leuthold Select Industries fund, hasn’t lost faith in a sector-based strategy.

“Our thesis is that the big moves are made by groups,” Floyd says. “If you get the groups right, it will be much easier to get the stocks right.”

Leuthold Weeden Capital Management, which has $250 million in assets under management, started its Select Industries fund in June 2000, just as the bear market was starting to bite. Since then Floyd and comanager Steven Leuthold have built the fund’s assets to $11 million. It has been rough sledding for the fund recently, and its return of -16% since inception seems nothing to brag about, except that a passive investment in the S&P 500 is off 35% over the same period.

Floyd’s selling pitch is quantitative analysis. He and Leuthold parse 2,000 stocks into 140 industry groups, which are then ranked according to 30 criteria. Most of the screening items are crunchily objective; they include such factors as earnings growth, cash flow (in the sense of net income plus depreciation), insider activity, relative strength, earnings estimate revisions and present versus historical valuations. But the pair add in some softer subjective scores, such as their assessment of economic or political risks affecting an industry.

The 30 criteria are then grouped into seven broad categories: value, growth, contrarian, technical, judgmental, long-term price momentum and insider activity. Industry groups scoring highest by these seven measures rise to the top of the fund’s shopping list. From there Floyd and Leuthold start prying out individual stocks using equally quantitative screens.

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Every six months or so, we run a screen to find companies where insider buying has significantly outpaced insider selling. The exercise consistently uncovers promising stocks.

Consider Borders Group, the Ann Arbor, Mich.-based book and music retailer. A look at insider activity over the past six months shows insider purchases of 95,000 shares and insider sales of 25,000 shares. Though just a drop in the bucket compared to the total shares outstanding, the net buying of Borders’ stock is probably a positive sign.

So why isn’t it definitely a positive sign? The motives for insider activity are never certain. An insider might be selling to raise cash to pay for college tuition or a summer home. On the other hand, an executive may be buying to impress Wall Street about his or her company’s prospects.

Bottom line: Insider activity is just one factor to consider when evaluating a stock.

Full story at Forbes.com

The members of the Forbes Platinum 400–the best big companies in America–meet some tough standards for return on capital and other performance measures. A handful of these companies are also on Wall Street’s discount rack.

One example: Safeway, which operates 1,775 supermarkets throughout the country. Yes, bargains often come with a catch: In Safeway’s case, there are concerns about slowing sales trends and slipping gross margins. Investors have also fretted the Pleasanton, Calif.-based food retailer will get crushed as Wal-Mart Stores moves more aggressively into the grocery business. Safeway stock trades 51% below a 52-week high.

At its recent price, however, Safeway goes for just nine times earnings per share for the past 12 months, versus a five-year historical multiple of 22. The average P/E for its Platinum industry group peers is 17. If Safeway can ward off the challenge from Wal-Mart, the stock could move closer to its historical valuation, or at least its industry average.

Another encouraging item is Safeway’s price-to-earnings-growth ratio, or PEG. Analysts reporting to Thomson Financial/IBES expect Safeway to post long-term annualized earnings growth of 12%. The stock’s price-to-earnings ratio (P/E)–calculated using projected next 12-month profits of $2.55–is 9, which gives Safeway a PEG of 0.8. A PEG below 1.0 often signals a cheap stock.

To find similar bargains, we looked for Platinum companies with multiples for price-to-sales, price-to-book value and price-to-cash flow below the averages for their respective industries. We dropped stocks with latest 12-month P/Es over 20. The seven stocks below carry an average estimated 2003 P/E of just 11, well below the S&P 500’s multiple.

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Let’s hope misery loves company. You may have had a bad year in the market, but the contestants in our annual stock picking contest have had a positively rotten one. Our bulls merely tracked the market, with an 18% loss over the past 12 months, while the bears saw their short-selling picks go the wrong way, rising 17%.

For the past two decades we’ve made an annual ritual out of asking a few brave investment professionals to go on the record with one stock to own or to short. Twelve offer up a buy, five a short-selling candidate. Winners get a return invitation. During the previous five rounds, the bears have done well on the whole, averaging a return 23 points worse than the market. As for the bulls in the prior five years, their picks have lagged the market by 4 points.

So what went wrong in 2002? For the bulls, the rebound in technology stocks never quite showed up the way a few thought it might. Nor did one analyst’s bullish call on Enron help matters. For the bears, expectations of disaster for the likes of Eastman Kodak didn’t quite happen.

There were a few standouts. The star bull: Jean-Marie Eveillard, a fund manager with First Eagle SoGen Funds. Eveillard bet on Security Capital, a holding company for real estate investment trusts. In May that firm was acquired by GE Capital. The deal entitled Security Capital shareholders to cash and fractional shares of ProLogis, an Aurora, Co.-based REIT. Eveillard’s pick was up 41% over the 12 months to Oct. 31.

For 2003 Eveillard returns with Tyco International, maker of things ranging from electrical components to security systems–and bedeviled by accounting questions and former chairman Dennis Kozlowski’s indictment. “A controversial company,” he muses, “but real businesses.” Eveillard says Tyco, if carved up and sold to other companies, would be worth $25 a share.

Full story at Forbes.com

Boosters of small capitalization stocks have had many of their arguments stripped from them in 2002. Weakness in both corporate earnings and the overall economy suggests that small caps aren’t primed to lead, as they have historically done in past recoveries. What’s more, with the downturn in the broader market over the last year, the valuation gap between large and small stocks has narrowed considerably.

So what’s the case for small stocks now? Transparency, says Todd McCallister, manager of the USAA Small Cap Stock Fund ( USCAX) . “They don’t tend to have as many special-purpose entities or off-balance-sheet financing,” he suggests. “You can figure out what’s going on easier.”

An economist by training, McCallister explains that market position is his most important consideration when making a stock pick. “We look for companies with limited competition or a barrier to entry,” he says. McCallister argues that companies with a high return on equity (net income divided by book value) often enjoy a good market position and the ability to finance themselves rather than having to issue new bonds or equity.

Example: Scientific Games, a provider of technology systems and services for instant ticket lotteries (as opposed to traditional statewide lotteries) and racetracks. With a 65% share of both markets, the $394 million (market value) company meets McCallister’s requirement of being an industry leader.

As the contracts for both its lottery and racetrack businesses are set up on a multiyear basis, Scientific Games also pulls in steady excess cash flow (cash from operations less capital expenditures and dividends paid), which amounts to $21 million for the latest 12 months.

At a recent $7, Scientific Games sell for 29 times latest 12-month earnings. That steep multiple doesn’t bother McCallister; he argues that a low P/E isn’t always a good sign when it comes to small cap investing. Reason: A low multiple is often a flag for a cyclical business, a risky bet in McCallister’s view.

Full story at Forbes.com