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.

Full story at Forbes.com

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

The S&P 500 index has lifted nicely from its 52-week low of 769, set earlier this month. Optimists have interpreted the move as a sign of a market bottom, and they may well be right. But that doesn’t mean all stocks are cheap.

Take Weight Watchers International, for example. Since a public offering in mid-November of last year, the stock has been on a tear, rising from $24 to a recent $47. True, Weight Watchers had some good news: Both its earnings and attendance at the company’s weight-loss classes have been above expectations. Recent controversy about the extent of America’s problems with weight and obesity has also helped the stock.

Still, Weight Watchers looks a bit too pricey. It sells for 36 times expected earnings per share for this year. Contrast that with an estimated annual price-to-earnings ratio of 18 for the S&P 500. And Weight Watcher’s price-to-sales ratio (PSR) of 7 isn’t exactly reassuring.

Another red flag: For its latest reported quarter, ended June, Weight Watchers’ total debt stood at 83% of total assets. That’s down from the prior quarter, but still looks ugly next to the 25% average for S&P 500 companies.

Like the other companies in the table, Weight Watchers has good fundamentals and promising growth prospects, but the market may have bid its shares too high in relation to its industry or historical norms.

Full story at Forbes.com

Only the most efficient companies fare well in a period of falling prices and slack productive capacity. Look at the success of low-cost operators such as Southwest Airlines and JetBlue, or Dell’s continued dominance in computer hardware. Predicting more such winners in the current economy isn’t easy, but one strategy might help: Bet on companies carrying a manageable debt load.

“Having debt is never so expensive as when inflation is low and moving lower,” says Jason Trennert, investment strategist and senior managing director at New York brokerage and economic research firm International Strategy & Investment.

Trennert and colleagues don’t expect a surge in corporate pricing power anytime soon. What’s more, even if trouble in the Middle East forces oil prices up in the short term (see story, p. 126), the deflationary trend is unlikely to abate. Why? Companies, still saddled with too much capacity, will find it hard to pass on energy costs to consumers. “There’s no way to sugarcoat a spike in oil prices,” Trennert warns.

Full story (reg. required) at Forbes.com

According to Edward Yardeni’s “Fed model,” it’s a great time to buy stocks.

An investment strategist with Prudential Securities, Yardeni derived this valuation technique from a 1997 monetary policy paper from the Federal Reserve. Roughly speaking, Yardeni’s model (never endorsed by the Fed) says that the fair value price for the S&P 500 is equal to estimated earnings for the index divided by the yield on the ten-year Treasury note.

According to Thomson Financial, estimated next-12-month earnings for the S&P 500 now stand at $54.53 a share. Divide that by the 3.996% yield on the ten-year Treasury, and you arrive at a fair value price for the S&P 500 of 1,365. As of last night, the index closed at 881.

Thus, by Yardeni’s model, the market is undervalued by 35%.

Full story at Forbes.com

The Morgan Stanley Capital International index of Asian stocks outside Japan shows a 3% gain since the end of August 2001–not too shabby next to the 23% drop for the S&P 500.

Switch up the time parameters, however, and the picture changes substantially. Over a ten-year horizon, the S&P 500 has appreciated 110% (excluding dividends), while that same Morgan Stanley Capital International index has risen just 15%. Throw Japan into the mix, and Asian equities show a 21% decline.

The discrepancy could explain why some Asian stocks still look like bargains relative to their U.S. counterparts. Take KT, a South Korean provider of fixed-line, wireless and other telecom services. The stock, available to U.S. investors as an American Depositary Receipt (ADR), currently trades at 0.9 times sales. Contrast that with BellSouth and SBC Communications which carry price-to-sales multiples of 1.7 and 1.9, respectively.

At 13, KT’s latest 12-month price-to-earnings ratio also looks reasonable relative to a five-year average multiple of 20. BellSouth sells for 18 times its trailing profits per share.

To be sure, comparing multiples across the Pacific may be of limited use. “[Asian] markets have a history of higher volatility, and the companies are smaller,” says Subodh Kumar, chief investment strategist with CIBC World Markets, a Toronto-based investment bank. “Maybe valuations should be lower.”

But Kumar is no bear on Asia. Instead, he prefers to focus on the growth aspects of investing in the region. Even with a slowdown in exports to the U.S. and Europe, he suggests, Asian countries will benefit from rising consumer demand within their own borders, as well as the surging economies of China and India.

Full story at Forbes.com