NEW YORK (TheStreet) -- To the growth, value and income schools of investing, now add the school of noise.
Writing in the recent Forbes, Marc Gerstein, author of the book Screening the Market, recommends stocks that have more value than "noise." Value is calculated from dividing the after-tax operating profit by the estimated cost of equity. The rest, states Gerstein, is noise, "reflecting growth expectations, stories, dreams, predictions and sentiment." Not value.
In terms of actual performance, nonfinancial stocks in the Russell 2000 Index with low noise, 25% or less, returned 16.3% over the last ten years, according to Gerstein. For those stocks that were amped up, the return was just 8.9%. This proves two immutable and enduring points of stock market investing: eventually, it does come down to earnings; and profits do count.
Without healthy profits, the after-tax operating numerator for Gerstein's equation will be pretty slim. Without robust earnings resulting in an alluring return-on-equity, the cost of equity will be very high. With a profit margin of under 1%, a return-on-equity of 1.50%, and a price-to-earnings ratio of well over 1400, both for the trailing twelve months, it is obvious why Amazon creates so much noise.
Investors should also add dividend here.
In his Forbes piece, Gerstein does not mention dividend income as a variable in the equation. Legendary investor John Bogle, founder of the Vanguard mutual fund family, claims that dividend income has provided more than 45% of the total return for equities over the 20th century. As detailed in a previous article on TheStreet, this is becoming a much more important component of the total return for Apple.
Down more than 10% so far in 2014, Apple's dividend payment of $3.05 on February 13 will be the only positive return so far this year for its shareholders. Neither Google nor Amazon pays a dividend. Off nearly 4% for 2014, owners of Amazon stock are suffering from a classic "dead money" holding. The same goes for Google, which has fallen nearly 1.25% for the new year.
Brinker International, which operates the restaurant chains of Chili's and Maggianos, has a ton of debt. (It is never good to have a debt-to-equity ratio of 6.75.) Much of that debt was used to repurchase stock, which skews the earnings ratios. For example, the return-on-equity is around 100%. Don't expect that to last. The 10-year average for a member of the Standard & Poor's 500 Index is 11.2%.
While the debt makes Brinker International unappetizing, investors should target the crosshairs on Olin, which makes Winchester-branded ammunition.
Olin produces chemicals used for soap, vinyl, and water treatment, among others. According to Gerstein, Olin has a negative "noise" value of minus 31. The price-to-earnings ratio is also low, about half of the S&P average. The dividend yield is more than 50% greater than the S&P average, too. Value investors should like the price-to-sales ratio of 0.81.
It's tough to argue with a formula that results in a 16.3% annual return. (That would more than double a portfolio every four years.) Looking for high dividend payments and low debt levels should improve the return even more for long-term investors buying into value and ignoring the noise of a stock.
At the time of publication, the author held no positions in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.