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THE TIMES 100: THE BEST COMPANIES IN CALIFORNIA : VIEW FROM THE STREET : PLAYING FAVORITES : Popular With Investor Crowd, Some Firms Aren't Necessarily Material for a Good Marriage

April 24, 1988|BILL SING | Times Staff Writer

What does it take to become a favorite on Wall Street?

According to The Times' rankings of the most popular California stocks--based on those with market values most exceeding annual sales or book value--it helps to be a fast-growing firm on the leading edge of technology.

Thus, the lists of "Overvalued" and "Favorites" include such high-flying biotechnology companies as Genentech and Cetus; bright medical products firms such as Alza and Diagnostic Products, and up-and-coming computer outfits such as Adobe Systems and Chips & Technologies.

It also helps to have a strong balance sheet. Thus, the strong rankings of Apple Computer, Neutrogena and WD-40, all with no long-term debt.

And it helps to be a takeover candidate, which accounts for the appearance of Lucky Stores, the supermarket chain facing buyout offers from American Stores or other possible suitors.

But just because these and other stocks score high on the charts doesn't necessarily mean investors should buy them.

First, some may be overvalued and risky, their stock prices more likely to fall than rise, analysts say.

Second, the ratios used in these tables--price to sales and market value to book value--could be misleading if viewed in isolation and without comparison to other measures of stock values.

"These ratios are only a starting point to investigate a company further," says Kevin Colosimo, vice president of MZ Group, which compiled the data for The Times. No one should buy a stock using these measures alone, he says.

Take the price-sales ratio found on the "Favorites" and "Forlorn" tables. It measures the price per share divided by annual sales per share. It's sometimes considered more stable and reliable than the more commonly used price-earnings ratio (which measures price per share divided by earnings per share), because a company's earnings can fluctuate sharply because of one-time gains or losses or manipulations through accounting gimmicks or tax changes.

Also, some new and fast-growing companies, such as those in biotechnology or computers, haven't recorded much profit yet, so their price-earnings ratios will be artificially high.

But the price-sales ratio must be looked at in context. Certain industries, such as biotechnology, tend to have higher ratios because of expectations of torrid growth in sales. For example, Genentech has a price-sales ratio of nearly 13, far above the combined ratio of about 2 for stocks in the Dow Jones industrial average. It is expected to double its sales this year over last year, says Larry Selwitz, a vice president of research at the Los Angeles brokerage of Bateman Eichler, Hill Richards.

By contrast, supermarket firms--with relatively slow sales growth and low profit margins--tend to have price-sales ratios of only 0.1 to 0.2, says Donna Hostetler, director of research at the Los Angeles brokerage of Crowell, Weedon & Co. Thus, the placement of Craig Corp., which owns 51% of the Stater Bros. grocery chain, and Vons Grocery on the list of lowest price-sales ratios is not far out of line.

The market-to-book ratio also has its limitations. It measures the relation of market value to book value, which is generally the value that a firm's assets are carried on its balance sheet. But that value often reflects the cost of the assets when acquired, not necessarily their value now, which may be higher because of inflation or lower because of soured business conditions.

That explains in part why Tejon Ranch Co., which owns 270,000 acres of land north of Los Angeles, ranks fourth on the market-to-book listing at about 20 times book. Its book value is far understated at only $18.1 million. (Tejon Ranch also ranks top in price-sales ratio, at slightly more than 13 times sales, in part because its annual sales of $27.2 million are low compared to the value of its assets. Tejon Ranch is 50% owned by Times Mirror Co., publisher of The Times, and by affiliates of Times Mirror.)

Conversely, banks and savings and loans dominate the list with the lowest market-book ratios because investors perceive their book values as overstated, given extensive problem loans that are not fully accounted for.

Several companies, such as Carter Hawley Hale and Tiger International, score high on market-book ratios not so much because their stock prices are skyrocketing, but because restructurings or poor earnings have battered their book values. Carter Hawley Hale, for example, actually has a negative book value, following a restructuring in which it spun off several specialty department store divisions and made a large cash payment to shareholders.

But perhaps the main reason for caution with high-ratio stocks is the danger that they may already be overvalued.

On average, about eight of 10 stocks with price-sales ratios of more than 3 lose money for shareholders during the ensuing five years as their prices fall, contends Kenneth L. Fisher, president of Fisher Investments Inc., a Woodside money management firm.

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