A Model Investor : Stock Manager Lets Computer Formulas Be His Guide

Louis G. Navellier, 39, is one of the best-known "quantitative" money managers: He picks stocks using an array of computer formulas to ferret out the most promising issues at any given moment--which typically are shares of fast-growing young companies.

Navellier, whose Reno-based firm manages nearly $2 billion in assets, believes that small-company stocks in general are about to resurge after a dismal last six months. He was interviewed by Times staff writer Tom Petruno.

Times: Blue-chip stocks, as represented by the Dow Jones industrials, have soared since the market's sudden dive in July. Meanwhile, smaller stocks have lagged badly. What's the problem in the small-stock area?

Navellier: There are a lot of theories. I think what's really happened is there has been a lot of profit taking and window dressing. . . . A lot of people sold [smaller stocks] to lock in gains for the year, and then they rotated to safer stuff to protect themselves.

Also, the Nasdaq market [home to most small stocks] is totally dependent on volume. The volume hasn't been there, so the stocks sagged. The Nasdaq market is more sensitive to volume than the New York Stock Exchange because Nasdaq is a network of dealers . . . while the NYSE has specialists who keep orderly markets.

Plus, the Nasdaq market always comes under selling pressure in October and November. That's why we have the "January effect."

Times: Meaning the bounce that smaller issues tend to get in January of each year, after tax-related selling at year-end runs its course. But that January effect has been occurring earlier in recent years-- more like December, hasn't it?

Navellier: Yes. Now it's always after Thanksgiving. We've been warning about this for months. We said D-Day [for the January effect to begin] would be Dec. 2.

Times: Well, smaller stocks have been acting better over the past week. But some people would argue that the stocks' lagging performance versus the blue chips must be rooted in the fundamentals--in other words, smaller companies' earnings prospects in the near future must not be as bright.

Navellier: Look, the Dow and the S&P; 500 have rallied because what's happened with bonds [the slide in yields] has been incredibly bullish. The fact that the Nasdaq stocks haven't woken up to this yet is what has everybody appalled. But I think Nasdaq will catch up with a vengeance now. This year's January effect will be that much more spectacular because the divergences [between big and small stocks] have been so much bigger.

My average stock is at 23 times next year's earnings per share. The S&P; 500 is now at 20 times next year's earnings. I've got a lot more earnings growth in my portfolio than the S&P.; There are a lot of unfounded fears [about smaller companies' prospects]. But there is no earnings problem out there. There are about 150 stocks we'll buy fundamentally today. Early in the year, there were only 65.

Times: Let's talk about your stock-picking method. Your starting point is high "alpha" stocks, issues that seem to have a momentum all their own, independent of the market. When did you begin working with these stocks?

Navellier: I went to Cal State Hayward 20 years ago. We didn't have personal computers. But two guys from Wells Fargo were teaching us at the time, and Wells had a mainframe computer that could dissect the stock market. We were helping them program their computer, and we also had access to put our own [investment] formulas on the computer.

Wells was a huge "index" fund manager [meaning it sought to create a fund to match the market's return]. When they were starting to build the index fund, they were struggling because a few stocks kept annoying them, kept beating the market. Those are now what we call high alpha stocks, stocks that move independent of the market. Wells' problem became my opportunity.

Times: So today you're using your own computers to screen the entire stock market for issues with high alphas, among other quantitative measures?

Navellier: Yes. We pick the creme de la creme with the quantitative screen, meaning those stocks with the best reward-to-risk ratios. I only work off the top 450 stocks, or 6% of my database. Then I take those top 450 stocks and run them through various fundamental filters to further stack the odds in my favor.

Times: Filters such as?

Navellier: Sales momentum, profit-margin expansion, earnings momentum.

Times: So you're trying to find the fundamental attributes that the market likes best, based on the stocks that are rising the fastest?

Navellier: Yes. We don't claim to be the smartest people out there. We just claim to be some of the best students on Wall Street. What I emphasize fundamentally is what has worked [in terms of stock performance] on a trailing three-year and trailing one-year basis. Depending on the environment, I'll have anywhere from four to eight fundamental stock screens.

Times: One thing that has shocked a lot of people since the market downturn in July is that many small companies with good "earnings momentum"--those whose profit growth is widely expected to accelerate--have seen their stocks suffer anyway.

Navellier: Earnings momentum doesn't work anymore. I think too many people [were] using it to pick stocks. Wall Street gets on these themes, and they just go in and out of favor. Our best screen now is earnings surprises.

Times: In other words, investors aren't interested in companies that are meeting high-earnings-growth expectations as much as they're interested in companies that are beating expectations by significant margins each quarter?

Navellier: Yes. [Since] the third quarter, only those stocks that had 10% or bigger earnings surprises really did well. PairGain Technologies and Cascade Communications are the two best examples of what's happened with earnings-momentum stocks. They have phenomenal growth, but in the third quarter they had only a couple cents' worth of earnings surprises. Investors shot the stocks.

Times: What else is your stock-screening process telling you now?

Navellier: There's a lot more of a "value" tilt in the fourth quarter. Stocks with high return on equity are back in, for example.

Times: Isn't there a danger in your system when the market is in transition from one theme to another, like growth to value, since you're looking backward?

Navellier: It takes my system about two months to shift gears. What I do fundamentally is like driving with the rear-view mirror. You don't see the bends coming up there, how the market is going to tilt. That is a risk. Also, I'm very dependent on the continued flow of funds in the market. If I could ever envision an environment that would cause money to flow out of the market, I know my system would be worthless.

Times: Your system, by definition, also makes you an aggressive trader. Nobody's going to accuse you of being a long-term investor.

Navellier: My cynical view of Wall Street is that if you want to be successful, you've got to buy early. You have to be in the early stages of institutional accumulation of a stock. Then I want all my institutional friends out there . . . all to pile in and drive my stocks higher. Eventually, you run out of institutions to buy. As that feeding frenzy backs off, the stocks get increasingly volatile, and my model tells me to start cutting back on them.

The most fascinating thing on Wall Street today is how fast it's become. You have to trade hyperactively. You can't have a static [investment] model anymore.

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The Navellier Way

* Hulbert Financial Digest, which tracks investment newsletter portfolios, says a composite of Louis Navellier's portfolios in his MPT Review newletter posted an average annual gain of 23.8% in the 10 years ended Oct. 31, compared with 14% for the Wilshire 5,000 stock index. MPT Review ranked No. 1 among 55 newsletters tracked by Hulbert. For a free sample of MPT Review, phone (800) 887-8671.

* The Navellier Aggressive Growth Fund, opened in December 1995, has gained 22.3% year-to-date, versus about 20% for the average general U.S. stock fund. The no-load fund's minimum investment: $2,000. For information: (800) 887-8671.

* The Navellier Aggressive Small Cap fund, opened in 1994, is closed to new investors. That fund rose 44% in 1995 and is up 15% year-to-date.

* Navellier also has begun managing funds for Northstar Investment Management. For information: (800) 595-7827.

* Among the stocks high on Navellier's buy list currently: Swift Energy; Coachmen Industries; and Global Marine, on the NYSE; and Ross Stores, Davox, Oregon Metallurgical and Stanley Furniture, on Nasdaq.

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