Zero In on Winners With These Neglected Numbers

Many investors look at the same tired old metrics day after day. But to find great stocks that others miss, you have to expand your vision.

Sure, you know all about the price-to-earnings (P/E) ratio and return on equity (ROE). Like many metrics, they're imperfect, and by themselves, they don't give you enough information on which to base an investment decision. Earnings, after all, can be (legally) manipulated to some degree by management, and ROEs are sometimes high because of steep debt. Hershey, for example, recently sported an ROE of 69%, but it has a lofty total debt-to-equity ratio of 4.23.

Don't neglect lesser-known metrics, though, because they can also tell you a lot about a company.

Revenue and earnings per employee
For example, you might look into how much money a company is raking in per employee (revenue), and how much of that it's keeping as profit (earnings).

Data: Motley Fool CAPS.

That table alone shows you that technology companies in general seem to wring more money out of each employee's work than the snack-and-beverage companies do. It also shows which contenders are most effective within each industry. Apple is the most impressive, but note that it still sports only three stars, compared with five for PepsiCo. That simply means that our Motley Fool CAPS community thinks PepsiCo is better poised to outperform the market at the moment, perhaps because Apple stock has gone up so much this year.

Ideally, you might jot down these numbers for the stocks that interest you, and then follow them over time to see whether they're trending up or down.

R&D
While the above numbers reflect how efficient a company has been, a look at its research and development spending can reflect its potential. Check out these examples.

Data: Motley Fool CAPS.

You can calculate these numbers easily for yourself by going to a company's income statement and dividing R&D by total revenue.

Even these numbers offer limited meaning on their own, though. It's clear that Microsoft outspends Apple. Yet it's also clear that Apple has been wildly and successfully innovative, so while it might be spending less, it's getting a lot from what it spends. It's also worth noting that while a small company might spend a larger proportion of its revenue on R&D, it still could have trouble competing with bigger companies that can devote more resources to R&D without stretching its budget to the breaking point.

If you want to learn more about the value of a company's R&D spending, you might want to read up on the research of Borje Johansson and Hans Loof, who found that companies with consistent R&D spending outperformed those that spent irregularly or not at all. Even more surprisingly, they also found that companies with occasional R&D spending tended to underperform those that didn't spend at all.

On a related note, in 2008, America's overall public and private spending on R&D was around 2.6% of our gross domestic product (GDP). That lags Japan's 3.3% but tops China's 1.4% and India's 0.7%.

The bottom line
Always look at the big picture, and gather lots of data points to consider. The more you know about a company, the better the chance that you'll discover a true winner.