Since I have finished the SSG on FDS, I thought we could use some of the other tools with the Stock Analyst software (also available on ITK) to help study the stock. As in the prior sessions, there is subjective judgment involved with the use of these tools, and my results are certainly not the last word.
I will start with Portfolio Management Guide. (PMG) Part 1 of PMG is populated with past years data. However, the most recent year (2008) uses data from page 2 of the SSG, along with the judgments used. (Most notably are the future PE levels.) Columns 5 and 6 are used in the PMG graph, which we will look at soon. Those figures provide us with strong buy, hold and sell guides. (See slide 1) If the price of FDS decreases to the point where the PE is 21 or less, we should consider this a buy signal, unless there is a fundamental change in the Co., such as depressed earnings. If the PE is between 21 and 31.5, we should continue to hold the shares we have, or if we don’t own shares, consider waiting until the PE retreats closer to 21 to buy shares. If the PE exceeds 31.5, we should consider selling some or all of our shares due to them being overpriced.
The PMG graph shows how price, PE and RV compare to our expectations and judgments in the SSG. (See slide 2) The price is in blue and the price scale is on the left of the graph; the PE is in red, and the PE scale is on the right of the graph. Looking at the graph, we see that the current PE is in the hold zone. I prefer to buy shares of any Co. when the PE is in the buy zone. (That is a preference not a hard rule.) If judgment is changed, or just more optimistic, so that the hold zone starts at 25 instead of 21, the current price of the stock is in the buy zone.(See slide 3)
Under the price/PE graph is the relative value graph. The computer makes the average PE equal to a Relative Value of 100, so that any PE above the average will have an RV >100, and any PE below the average will have an RV < 100. The average PE is found in column 5 in Part 1 of the PMG which is the same number in section 3 line 8 of the SSG. (See slide 4)
The PMG graph is helpful in determining if shares of a Co. should be purchased, or even sold. From the graph in slide 5, we see that the PE was in the upper zone (the sell zone) which is above the top red line. This means that the PE was more than 150% of it’s average. As would be expected, investor sentiment decreased and the price and PE of the stock returned to the normal range=100% to 150% of the average PE.
The price of the stock is also followed by PMG. The horizontal blue bars represent the buy, hold and sell zones for the price of the stock. These zones and prices are set in section 4 of the SSG. Looking again at slide 2 we see that the price of FDS is below the low blue bar, putting it in the buy zone on the PMG graph. You may wonder how the price could be in the buy zone while the PE is in the hold zone. The reason is that the SSG price forecast (where PMG gets it’s data) uses the average high PE (26 in the case of FDS) while PMG uses the average PE (21 for FDS).
Part 3 of PMG is used to monitor the price, earnings and PE of the stock on a monthly or quarterly basis. Tracking changes in any of these values is done to identify selling or buying opportunities. For example, if the PE gets above the high PE guideline (150% of the average PE) the price of the stock may be overvalued and some or all the shares may need to be sold. This happened to FDS in June 30 of 2007. (See slide 5 orange circle) The PE of the stock reached 35.2, above the high level of 31.5 and the price of the stock was $68.35. As pointed out in an earlier session, the PE of a stock can jump if there is a decrease in Co. earnings without a decrease in the price of the stock at the same time. This did not happen;the price was driven up by positive investor sentiment. 3 quarters later, with increasing earnings (red rectangle) there is less enthusiasm for the shares and the price dropped. I am not suggesting that it was a mistake to hold the shares when they were overvalued. I know from experience how difficult it is to sell stocks that are rising. I seem to do better if, before I make a purchase, I have PE (and therefore price) guidelines. It helps to take some of the emotion of selling a stock out of my thinking. It does make sense to review your stocks and look for overvalued shares and consider selling a portion of them.
On the flip side, the PE of the stock is now at a low level it has not seen for the past years. This is in spite of rising earnings. Could this signal a buying opportunity, or adding to your current position?
Another useful tool when looking at the purchase of a stock is the Challenge Tree. This tool is used when you are considering replacing a stock you currently own, or if you have 2 candidates which look like potential buys. Before starting the comparison, you must update your SSG since that is where the information will come from. (In other words, you need to go through the same judgments for the Co.s that we did for FDS in the 1st 3 days.) For this forum, I will challenge a stock I currently own, SPLS with FDS. (See slide 6) You can see that the challenge tree gives you a snap shot of the Co.s involved. Further research should be done. The primary bit of data is the 5 year potential growth. (Red ovals) Another consideration is the cost of switching one stock for the other. (See slide 7) Because the 5 year gain potential is very similar with these 2 stocks, the growth lines on the graph are very close together. There would be more separation if FDS was predicted to grow faster and have a greater 5 year potential gain than SPLS. Also note at the bottom of the left hand table, in the box it states “3.8 years to break even”. That is too long to wait to break even by trading SPLS for FDS. (There are too many things that could change your judgments in 3.8 years.) I do not want to wait more than 2 years to reach the break even number when trading. Another nice feature of this screen is that it tells you how many shares of the new Co. can be purchased with the sale of the Co. you currently own.
I feel that the Challenge Tree is incomplete in the data it provides. For that reason, rather than using it, I usually tile the SSGs vertically so I can directly compare the entire guide on one window. (See slide 8 and 9)
PERT Report is another tool used to help with buy and sell decisions. It allows easy determination of how your companies are performing and whether their performance is as you had predicted.
On slide 10 we see the PERT Report for FDS. We start by looking at how the Co. grew in earnings and sales. Comparing the actual earnings growth and sales growth with our predictions from the SSG, we see that FDS grew earnings by 13.5% which is exactly what we predicted in the SSG. The Co. also grew sales by 20.6% which is higher than the 14% we predicted. (Sales increased greater than predicted.) The next column shows that pre-tax profit was 31.9% in the last quarter. That compares unfavorably to the 5 year average of 35.2%. This may be an area of concern for the future earnings of the Co. It should stimulate you to look at PERT A to see if this is a trend or a 1 time occurrence.
The growth of the Pre Tax income was 12.9% in the last Qtr. (yellow oval) This may also be an area of concern because this is not as great as the growth of the Co. sales or earnings. Again, look at PERT A for a trend. You may also want to check the management discussion in the recent 10Q to see what explanations are offered. In the case of FDS, management discusses the decrease and attributes it to the Performance Based bonuses that will be given out in 2008.
Also notice in the report that the trailing 12 month EPS growth is 26.9%. Because earnings usually drive the price of the stock, this is another valuable number to look at.
Now look at the current and leading RV. These numbers tell you if there is value in the stock at the current prices. The RV numbers are near 100 and therefore offer value at these prices. Shares should generally be avoided if they are trading at an RV of 150 or higher. If you purchase shares of a stock at a PE that high, the earnings could increase each year, but the price of the stock could decrease due to contraction of the PE.
The PEG of the stock is high; as stated in an earlier session, that is due to a low growth prediction, rather that an excessively high PE.
The PERT Report shows a favorable Upside:Downside ratio and an attractive potential total return.
So there is nothing in the PERT report to suggest the selling or avoidance of this stock. The only area of concern is the Pre Tax profit margins.
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