Investment Education for Individuals and Clubs Since 1951

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Investment Education for Individuals and Clubs
Since 1951
Fundamental Analysis the NAIC WayOctober 2,
2004 Presenter Brian Goodhart
DC Regional Chapter - NAIC
The D.C. Regional Chapter of the NAIC is a
voluntary education and information-based
organization that does not make recommendations
on specific securities.
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Course Outline

• Introduction to NAIC
• NAICs Investing Philosophy and Strategy
• NAICs Method
• Tools

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Introduction to NAIC
D.C. Regional Chapter - NAIC
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What Is the NAIC?

• National Association of Investors Corporation
• Founded in 1951
• Non-Profit
• Volunteer Organization
• Investment Education and Information
• 264,947 Total Members
• 23,360 Investment Clubs
• 30,233 Individual Members

Source NAIC web site http//www.better-investin
g.org/about/fact.html
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NAIC Membership Profile

• 67 women
• Median age 55.8
• 31.4 are under 50
• 35.7 are 60 or older
• 94 attended college, 74 have degrees
• Average household income 114,000
• 94 own their own residence
• Average portfolio value 388,000
• Aggregate investment 116 billion

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The Typical NAIC Investor

• Follows a long-term buy-and-hold strategy
• Not buy and forget
• Average holding period is greater than six years
• No technical analysis, no options, no shorting,
  no trading

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NAIC is Volunteers
NAIC is a non-profit education organization 501c
(3).
NAIC neither recommends nor endorses specific
securities.
All instructors and assistants are volunteers.
When one teaches, two learn
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Regional Chapters

• Over 110 Regional Chapters
• Over 1,500 volunteer members
• Classes
• Investors Fairs

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Web Site http//www.better-investing.org
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Individual Membership
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Club Membership
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Subscriptions
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Annual Convention
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Regional Conferences and Compufest
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Better Investing Magazine
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BITS Online
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Stock Selection Handbook
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NAICs Investing Philosophy and Strategy
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Four Principles

• Invest regularly for the long term (5 years)
• Reinvest all income (interest and dividends)
• Invest in leadership growth companies
• Companies whose records suggest they are growing
  faster than the general economy, and will be
  worth substantially more in the future
• Diversify your portfolio by company size and
  industry

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Company Size

• Small Under 400 Million in sales
• Medium 400 Million to 4 Billion in sales
• Large Over 4 Billion in sales

Size is a factor in a companys ability to grow
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Stocks, Bonds, Cash, and Inflation
1925 - 1997
Ending Wealth
Average Return
10,000
1,000
100
10
1
.10
1925
1935
1945
1955
1965
1975
1985
1997
Hypothetical value of 1 invested at year-end
1925. Assumes reinvestment of income and no
transaction costs or taxes.
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Long-Range History of Stock Prices
12,000
11,000
10,000
9,000
8,000
Dow Jones Industrial Average (DJIA)
7,000
6,000
5,000
4,000
3,000
2,000
1,000
2000
1990
1980
1950
1970
1900
1940
1960
1920
1930
Year
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Axioms Underlying the NAIC Approach

• In the long run, growth in Sales will drive
  growth in Earnings per Share which will drive
  growth in stock price.
• Past performance is our best indicator of future
  performance (assuming management doesnt change).

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NAICs Method
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Two Sets of Tasks

• Evaluation and Acquisition
• Portfolio Management

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Evaluate and Acquire

• Is this a good company?
• Degree and consistency of growth in sales
• Degree and consistency of growth in Earnings per
  Share
• Profitability trend and position versus
  competitors
• Return on Equity trend and position versus
  competitors
• If it is a good company, can I currently buy its
  stock at a good price?
• Current price in relation to earnings
• Current price/earnings relationship compared to
  historical performance

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NAIC Tools for Evaluation/Acquisition

• Is this a good company?
• Degree and consistency of growth in sales
• Degree and consistency of growth in Earnings per
  Share
• Profitability trend and position versus
  competitors
• Return on Equity trend and position versus
  competitors
• Is its stock selling at a reasonable price?
• Current price in relation to earnings
• Current price/earnings relationship compared to
  historical performance

Stock Check List (SCL)
Stock Selection Guide (SSG)
SCL and SSG
Also the Stock Comparison Guide (SCG)
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Strategy Fundamental Analysis

• Four Categories of Judgment
• Make History Relevant
• Estimate Future Company Performance
• Estimate Future Price Performance
• Accept or Reject

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Make History Relevant

• Eliminate non-recurring events
• Discount early rapid growth
• Eliminate inflated Price/Earnings Ratios

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Estimate Future Company Performance

• Estimate Future Revenue and Earnings Growth
• Estimate Future Profit Margins, Taxes, etc. (for
  method of estimating future EPS growth based on
  future sales growth known as the Preferred
  Procedure)

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Estimate Future Price Performance

• Estimate Future Price/Earnings Ratios
• Estimate Future High and Low Prices

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Accept or Reject

• Accept Results and Continue
• Reject the Stock
• Iterate Place Interesting Companies on a Watch
  List

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SSG Front Page Visual Analysis

• Evaluate
• historical
• growth rates of
• Sales, Pre-Tax
• Profit, and
• Earnings
• Estimate future growth rates of Sales and Earnings

• This funny-looking graph paper means two things
• The straighter the line, the more consistent
  the growth
• The steeper the line, the higher the historical
  growth

The first two good company questions

• Degree and consistency of growth in sales
• Degree and consistency of growth in Earnings per
  Share

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Estimate Sales Earnings

• Evaluate
• historical growth
• rates of Sales
• and Earnings
• Estimate future growth rates of Sales and Earnings

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Evaluate Historical Growth

• Look at Recent Growth First
• Look at Quality of Growth
• How Strong is the Growth (slope of line)?
• How Consistent is the Growth (straightness of
  line)?
• Eliminate Irrelevant Data
• One or two blips earlier in companys history
• Rule of Thumb Never eliminate an outlier if
  doing so increases the historical growth rate
• Discount Early Rapid Growth (possible rule of
  thumb eliminate early years of explosive growth
  until historical growth rate stops declining)

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Quality of Growth
The first key to successful investing is to
recognize predictable growth. The only skill you
require is being able to tell a straight line
from a crooked one. - Ellis Traub
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Quality of Growth
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Eliminate Irrelevant Data Early Blips
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Eliminate Irrelevant Data Early Blips
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Projecting Sales Growth Do Your Homework

• You Just Analyzed Historical Sales Growth
• Conduct Research on Industry and Economic
  Forecasts

• Understand Management Strategies for Increasing
  Sales
• (Past performance is no indication of
  future returns)

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Evaluate Management
A Pre-Tax Profit on Sales (Profit Margin)
B Return on Equity

• Result of management strategies
• Check for consistency
• Compare to industry average
• Is trend steady or up
• Declining PTP is especially acause for concern

Third and Fourth Good Company Questions

• Profitability trend and position versus
  competitors
• Return on Equity trend and position versus
  competitors

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STOP!

• You have reached the proverbial barbed wire
  fence
• Does the company meet your standards for quality
  in Sections 1 and 2 of the SSG?
• If it doesnt, stop now
• Remember the worse a company performs
  (fundamentals, not price) the better a value it
  will appear to be.

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P/E Ratios Make History Relevant

• Eliminate Inflated P/Es especially important
  after the recent bubble
• Ralph Seger Look at the historical record.
  Are there some values that common sense says to
  disregard? Frequently, when EPS drops below
  trend levels for one year, the price does not
  drop in proportionIf the historical high P/E
  ratios seem to discount not only the future, but
  the hereafter, it is prudent to lower them to a
  reasonable level.

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Estimate Future High Low P/E
Eliminate outliers
General Electric
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P/E Considerations

• Compare P/E to other companies in same industry
  
• PEG ratio P/E / Projected Earnings Growth
  Rate
• A company that has a P/E of 30 and is growing
  earnings at 20 PEG 1.5
• is a better value than
• a company with a P/E of 20 that has an
  earnings growth rate of 10 PEG2

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Setting P/E Lore or Rules of Thumb

• The PEG Approach
• Set high projected P/E 1.5 x projected growth
  rate (or 2, or whatever)
• Set low projected P/E 1.0 x projected growth
  rate
• The Traub Approach
• Dont set high projected P/E greater than 30.

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Estimating High EPS

• Estimated High EPS Your Estimate of EPS Five
  Years Hence
• Check Preferred Procedure, compare forecast high
  price with VL estimate

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Estimate High Earnings/Share
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Estimate Low EPS

• Very Conservative The Most Recent Actual
  Earnings Are Your Default Estimate of Future EPS
• Your Choice Last Full Fiscal Year or Most
  Recent Four Quarter

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