Sizing Up the Investment Companies

 | Oct 26, 2012 | 9:15 AM EDT  | Comments
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In this column, I write about investment opportunities that I believe are worthy of your consideration. This time, I'm writing about opportunities in two companies that make investments.

Main Street Capital (MAIN) is an investment firm that provides long-term debt and equity capital to companies that have annual revenue between $10 million and $150 million, and debt capital to companies larger than $150 million. Founded in 1997, Main Street has invested in dozens of companies in a wide variety of industries, including AmeriTech College, a for-profit college, Cafe Brazil, which operates full-service restaurants and coffee houses, Ceres Management, which does business under the Lamb's Tire and Automotive Centers moniker, and NRP Jones, which manufactures products used in the oil, natural gas, construction and mining industries.

To choose a stock to recommend, I rely on my guru strategies, which are automated strategies I base on the investment approaches used by some of Wall Street's greatest investors. Peter Lynch, one of the greatest mutual fund managers of all time, created a strategy that I use, and this strategy looks very favorably at Main Street.

Lynch focused on the P/E/G ratio, which is price-to-earnings relative to growth, a measure of how much the investor is paying for growth. A P/E/G of up to 1.0 is acceptable (that means you are paying $1 for every percentage point of growth), and below 0.5 is considered very compelling. Main Street is in this very compelling territory, with a P/E/G of 0.22. This is based on a P/E of 8.71 and a growth rate of 38.83%, which is the average of the three-, four- and five-year historical EPS growth rates. In addition, Main Street's equity-to-asset ratio, which is used when analyzing financial companies, is a very strong 63.0%, and its return on assets is also very strong at 11.5%, way above the strategy's 1% minimum.

Colony Financial (CLNY) is another type of investment company. It is a commercial real estate finance company that acquires, originates, invests in and manages a diversified portfolio of real estate-related debt investments, primary commercial mortgage loans, as well as other types of commercial real estate-related debt. Its founding dates back to 1991 and it has 11 offices in nine countries.

Like Main Street, Colony Financial gets high marks from my Lynch-based strategy. Its P/E/G ratio is a very desirable 0.45, while its equity-to-asset ratio is an impressive 77.0%. And its return on assets is a solid 6.99%.

Both of these companies are excellent investment prospects in themselves. But in addition, they provide a means of getting exposure to the investment markets. If your portfolio does not include such exposure, they should be of particularly strong interest to you.

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