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

December 03, 1996

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.

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