ATLANTA, GA (Oct. 18, 1999) -- In last week's column, I expressed my frustration with not discovering a statistically significant financial measure for screening Drip stocks, in particular, companies in the "Pathfinder" portfolio. I began with a handful of companies that are opening the pathways through the Internet, and all of these companies have Drips. I worked backward with data I obtained from Value Line, and examined a number of key measurements to see if there was a way to have predicted which of these companies would perform better than the others. Unfortunately, none of my results were satisfactory, so I wanted to try again with a larger (and more random) sample.

This time I tested 29 companies. Not all of them have Drips, and for a few it may be a stretch to say they are "Pathfinders." In particular, it's debatable whether Western Digital (NYSE: WDC), Seagate (NYSE: SEG), and Iomega (NYSE: IOM) are contributing much to opening up the Internet. However, they come under the definition of high-tech stocks, so I included them. I'm assuming that investors have valued them the same way they value well-performing "tech" stocks, and I needed a wide range of performers. Unfortunately, I had to eliminate AT&T (NYSE: T) and Lucent Technologies (NYSE: LU) because Lucent was spun off from AT&T during the period we're studying, and the returns are too hard to figure.

To see my results in spreadsheet format, you can check my website.

If you look down below all those columns of stocks and numbers, you will see four financial measures: Net Margin, LT Debt/Equity, Five-Year Revenue Growth Rate, and Return on Equity. I calculated a "Correlation" of these measures to the annualized return of the stocks. I won't bore you will all the nasty statistics, but the closer the "Correlation" is to one, the more the two sets of data correlate. If we had a 1.0 correlation on any measure to the annualized return, we could be sure that measure predicts the stock's performance. However, that didn't happen, and we can't expect it to.

Why is this? I suspect it's a paradox of the market that once a measure is found to predict stock price performance with any accuracy, it becomes worthless. That's because the stocks that are found to be a good buy with that measure will skyrocket in price to meet some expected return. So, we can't expect any measure to come out perfect. It's enough to make your head spin, isn't it?

What measure came out the best? The five-year revenue growth rate came up with a correlation of 0.513, which was much higher than the other three measures. The next closest was net margin, which was 0.16. The other two were -0.08 for long term debt/equity and 0.06 for return on equity. None of those three comes out high enough to be considered useful in my opinion.

For the next step, I checked to see what we should use as the cutoff for five-year revenue growth rate. Twenty-five percent of the companies had a growth rate of 27% or greater, so I used this. The average annualized return for my collection of stocks was 33% (not bad -- it gives a good case for a "Tech Stock Index Fund," doesn't it?). However, if we screen out the companies with five-year growth rates of less than 27%, we come up with an average annualized return of 65%. HOWEVER, I wouldn't use this measure by itself, because my range of results was spread out. (To avoid boring those not mathematically inclined, the remainder of this statistics discussion can be found on my website.)

So, now we have two measures to screen our Pathfinder stocks: the "What You Know" measure discussed over the past weeks, and the five-year growth rate. In a couple of weeks, I'll apply those to the stocks in our Pathfinder list and see what we get.

Tomorrow I'm going to visit Scientific-Atlanta (NYSE: SFA) armed with questions sent to me by Drip port readers. I'll write about that visit next Monday. I'm looking forward to covering this and our ongoing Pathfinders study in the next few weeks. Your comments are very helpful. Please don't hesitate to e-mail me: George Runkle at TMFRunkle@AOL.com.

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