Estimating EPS « Fundamental Investing Using the Stock Selection Guide (SSG) by armin fields

Contemplating Cognizant (CTSH)

November 19, 2009

This year, Forbes, Business Week and Fortune magazines all have recognized Cognizant Technology Solutions (CTSH) as an outstanding growth company. Wikipedia mentions six, noteworthy achievements:

- In 2009, CTSH ranked #7 on Forbes’ 25 Fastest Growing Tech Stocks, #31 on BusinessWeek’s Top 50 Companies, #51 on BusinessWeek’s 100 Hottest Tech Companies, #90 on Fortune’s 100 Fastest Growing Companies (seventh consecutive year on the list), #716 on the Fortune 1000, and was also listed on Forbes’ The Global 2000 (no rankings, Software and Services Industry). [See footnote 1 for URLs]

COMPANY BACKGROUND:

- CTSH is a global information technology, consulting and outsourcing services company headquartered in New Jersey, with some 50 IT or development centers worldwide, and with most of its 62,000 employees in India.

- According to its latest Annual Report, CTSH is organized into four segments and its 2008 revenue was: 46% from financial services (up 28%), 24% from healthcare services (up 36%), 16% from retail/manufacturing/logistics (up 38%), and 14% from communications and other high tech. About 79% of its total revenue came from customers located in North America.

- Morningstar thinks CTSH’s business model provides a competitive advantage because its management is based in the U.S. and key employees are located on-site. In 2008, Cognizant had some 565 customers (up from 500 in the prior year and 400 two years ago), with 12,000 of its employees based in North and South America and 2,700 in Europe.

- With either Hemscott or S&P data, sales growth has been spectacular averaging more than 47% per year over the last 10, 5 and 3 years, and EPS growth more than 41% over the same periods.

** Growth has slowed: last year’s annual Sales were 32% and EPS was 25% (Hemscott) or 26% (S&P).

** Growth in Quarter 3 was up a solid 16% Sales and 18% EPS (so far only reported by S&P) while Q2 growth was up 13% Sales and over 34% EPS (both S&P and Hemscott).

- Value Line’s latest report concluded that CTSH’s stock price has risen over 115% since the start of 2009, and over 15% since its August report, and now offers limited price appreciation over the next 3-5 years.

COMPANY FINANCIALS:

- VL rated Cognizant an “A” for Financial Strength with no debt and almost $1 B in cash assets. Morningstar said much the same.

- The one-click Annual Report spreadsheet by Bob Adams gave Cognizant’s 2008 A.R. a 44 out of 100 with 9 Bullish and 6 Bearish results:

** The 9 Bullish or good things included: Sales are increasing and are increasing faster than related costs, no long-term debt, and gross profit margin is growing;

** The 6 Bearish or not-so-goods included: Accounts Receivable are increasing, free cash flow growth is less than sales growth, and shares outstanding are increasing.

DISCUSSION:

The following table compares the SSG by BudS, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock. The only difference between my two SSGs is that Armin-1 uses Hemscott-Morningstar data from the StockCentral website (like Bud did) while Armin-2 uses S&P data from the BI website.

After the table, I discuss issues identified by the comparison and, once again, ask some questions that I hope you’ll respond to (there are no “right” answers).

Cognizant Technology (CTSH)	BudS	Armin-1	Armin-2	Take Stock
Date	10-7-09	11-13-09	Same	Same
Data	Hemscott-Morningstar	Hemscott-Morningstar	S&P	Hemscott-Morningstar
Price	$39.47	$44.77	Same	Same
52 week High & Low Price	$39.61 & $14.38	$44.77 & Sane	Same & Same	Not Included
Last Q of Reported Data Ending on	Q2 ending 6-30-09	*Q2 ending 6-30-09*	*Q3 ending 9-30-09*	Same
Software Used	TK 6	TK 5	Same	TS Online

Project Growth From End of	Last Q	Same	Same	Last FY
Sales Growth	15.00%	16.00%	Same	20.00%
EPS Growth	15.00%	16.00%	Same	20.00%
High PE	33.3	25.5 (from 2008)	25.8 (from 2008)	30.0
High EPS	$3.23	$3.37	$3.53	$3.59
High Price	$107.60 *(65% > VL on 8-21-09)*	$85.90 *(32% > VL)*	$91.10 *(40% > VL)*	$107.70 *(65% > VL)*
*Value Line Estimated High Price =* *$40-65 on 8-21-09 and $50-75 on 11-20-09*
Low PE	22.4	10.2 (from 2008)	10.0 (from 2008)	17.7
Low EPS	$1.15 (from 2007)	$1.60 (ttm)	$1.68 (ttm)	$1.58
Low Price	$17.30(“other” option)	$16.30 (low PE x low EPS)	$16.80 (low PE x low EPS)	$22.07 (low PE x low EPS)
Upside/Down	3.1	1.4	1.7	3.9 imputed
Total Return	*22.2%*	*13.9%*	*15.3%*	*22.3%*
SSG Buy Under	N/A	$33.70	$35.38	$41.98
RV/PRV (no outs)	70.7/61.6	80.2/69.3	85.3/73.6	Not Included
Quality	Not Included	Same	B+	*3.2 unacceptable*

PTPM – 5 yr ave	19.8% *trend down*	Same *Same*	Same *Same*	19.8% *Same*
ROE – 5 yr aveEnd Equity	Not Included	21.5% trend even	21.0% trend even	Not Included
ROE – 5 yr aveStart Equity	31.1% *trend down*	Same *Same*	30.5% *trend down*	31.2% *trend down*
Debt to Equity –5 yr ave	-0- trend even	Same Same	Same Same	Not Included

Data Differences:

- CTSH ended its last quarter on 9-30-09, but that data is only reported by S&P at this time. This doesn’t happen often, but is something to be aware of because the choice of SSG data from either Hemscott or S&P can make a noticeable difference whenever we project growth from the last quarter (as I usually do).

- My SSGs were done 5 weeks after Bud’s and, in the interim, CTSH’s price rose 15% to a 52-week high. I hope he bought it below $40 per share.

Estimating Future EPS Growth:

(A) Bud estimated 15.00% EPS growth and his First Cut write-up explained that he was being conservative “since few companies average over 15% over the long haul.”

** CTSH is, in fact, one of those exceptional companies and its historic EPS growth has averaged much more than 15% over the long haul: 40.5% over the last ten years; 42.5% over the last five; 32.8% over the last three; and 25.0% last year, it’s lowest ever (all with Hemscott data which Bud used).

(B) The seven analysts I always check for every SSG were estimating long-term EPS at an average of 20.03% with Value Line high at 28.50% and FactSet via Morningstar low at 17.30%. Reuters and FactSet CallStreet via CNNMoney were both 18.00%, Zacks was 18.14%, S&P was 20.00%, and Thomson-Reuters via Yahoo Finance was 20.30%.

** The consensus of the 8 analysts at FactSet CallStreet ranged from a high of 20.0% to a low of 12.0% as did the 9 analysts at Reuters. And, without Value Line’s estimate of 28.50%, which looks like an outlier to me and which didn’t change in its 11-20 report, the average of the six other analysts dropped to 18.62%. That average less 1 Standard Deviation equals 17.40% and less 2 SDs = 16.18%.

** I projected 16.00% EPS growth based on the analyst average without VL less 2 SDs which, I think, is a conservative approach based on reason. My 16% estimate is not much different than Bud’s 15%, but at least I’m relying on a rational method, not my gut feelings, and also learned what’s unduly conservative or excessive. For example, I thought the 12.0% low estimates at FactSet Call Street and at Reuters were too low by comparison.

** For how I estimate EPS for all my SSGs, see: Estimating EPS

(C) Take Stock used 20.00% EPS which is the highest it will ever estimate for any company no matter how high its actual growth. In this regard, Take Stock is like Bud as both set (arbitrary) limits on future growth that are unrelated to the company’s actual growth.

Forecast High and Low PEs:

(A) Bud did not explain, but his 33.3 Forecast High PE seems to be based on eliminating the three years 2004-2006 and his 22.4 Forecast Low PE on eliminating the 2 years 2004-2005.

(B) I saw that CTSH’s High and Low PEs were trending down and used 2008, the lowest in the last five years, as my Forecast High and Low PEs (25.5 and 10.2).

(C) Take Stock used 30.0 as its Forecast High PE, isn’t designed to look for trends, and always uses a two-step methodology:

** TS first eliminates the five highest High PEs in the last 10 years and averages the rest. It then limits High PEs to 1.5 times its estimated EPS growth or, in this case, to 30.0 (1.5 x 20.00 = 30.0) which is the maximum it will ever forecast no matter how high the company’s actual PEs. A 30.0 High PE is equivalent to a 1.5 High PEG maximum.

** TS used 14.7 as its Forecast Low PE which came from eliminating the five highest Low PEs in the last 10 years and averaging the rest. If that average was more than 20.0 (not the case here), TS would limit the Low PE to a Low PEG of 1.0 max (1.0 x 20.00 = 20.0).

Forecast High Price:

(A) With his 15.00% estimated EPS and 33.3 High PE, Bud got $107.60 for his Forecast High Price which was a whopping 65% greater than the high end of Value Line’s estimated $40-65 High Price on 8-21-09 and 43% greater than VL’s updated $50-75 estimate on 11-20-09.

** That’s way too high for me and I never want to substantially exceed VL’s estimate; see: Determining What’s Reasonable and What’s Not: An Update

(B) With my 16.00% estimated EPS and 25.5 High PE, I got $85.90 for my Forecast High Price which was 32% greater than VL (and only 14.5% greater than VL’s updated estimate).

** 32% is usually too high for me and I prefer to be no more than 20-25% higher than VL. Because both of my SSGs did not statisfy the Buy criteria (UD >3.0 and TR >15%), there was no point to lower my judgments.

(C) With its 20.00% estimated EPS and 30.0 High PE, Take Stock got $107.70 for its Forecast High Price which, like Bud, was also a whopping 65% greater than the high end of Value Line’s estimated High Price of $40-65 and also 43% greater than VL’s updated estimate.

Forecast Low Price:

(A) Bud inexplicably reduced his Forecast Low EPS to 2007’s $1.15 and then disregarded the Low EPS x Low PE option, which is most appropriate for growth companies like CTSH, and decided to use $17.30 which he also did not explain.

(B) & (C) Take Stock and I used the same method (Low PE x Low EPS), but got much different results because TS used a much higher Low PE than I did (17.7 vs 10.2).

Quality:

(A) Bud and Armin-1 used Hemscott-Morningstar data which does not provide any Quality rating.

(B) Armin-2 used S&P data and gave Cognizant a B+ Quality rating which ranked fourth out of its 8 ratings.

(C) Although Take Stock gave Cognizant high marks for its recent and historic growth, CTSH’s downtrend in PTPM resulted in an overall Quality rating of 3.2 which is unacceptable. TS requires a 3.4 minimum to pass muster and a 6.7 is desired.

Pretax-Profit Margin (PTPM) and Return on Equity (ROE):

- Cognizant’s five-year average PTPM of 19.8% is trending down which usually is a red-flag warning sign. However, CTSH is better than its Industry Average of 16.7% (Business Software & Services, Hemscott data) and ranks 14^th out of 135 companies.

- Cognizant’s five-year average ROE of 21.5% is also trending down. But, that is far less than CTSH’s industry average of 78.3% which is substantially distorted by 5 companies with ROEs over 100%. Nevertheless, CTSH still ranks 15^th out of 135 despite the distorted average.

- For more on using Industry Information to inform our SSGs, see: Investigating Industry Info

Questions:

(1) Are you bothered by Cognizant’s PTPM and ROE downtrends, or does my assessment satisfy you that they are not red-flag warning signs of potential trouble? If you’re not satisfied, what else would you want to look at??

(2) CTSH has excellent Sales and EPS growth (both historic and expected), but does not satisfy the SSG’s minimum BUY criteria of a 15.00% Total Return and a 3.0 Upside/Downside Ratio.

At this time, would you buy Cognizant based on my SSG with its 13.9% TR and 1.4 U/D? Would you have bought it based on Bud’s SSG with a 22.2% TR and a 3.1 U/D??

I like CTSH a lot and have followed it for several years; see: Two Small Company Stocks: Cognizant Technology Solutions (CTSH) and Jack Henry and Associates (JKHY), September 5, 2006 (CTSH is no longer considered a small company).

- Armin

_________________________________________________

Footnote 1:

Forbes 25 Fastest Growing Tech Stocks (#7 in 2009), http://www.forbes.com/forbes/2009/0216/048b.html

BusinessWeek’s Top 50 Companies (#31 in 2009), http://images.businessweek.com/ss/09/03/0326_bw50/21.htm

BusinessWeek’s Hottest Tech Companies in 2009 (# 51), http://images.businessweek.com/ss/09/05/0521_IT_100/52.htm

Fortune 100 Fastest Growing Companies (seventh consecutive year, #90 in 2009), http://money.cnn.com/magazines/fortune/fortunefastestgrowing/2009/snapshots/90.html

Fortune 1000 (#716 in 2009), http://money.cnn.com/magazines/fortune/fortune500/2009/full_list/701_800.html

Forbes The Global 2000 (no rankings, 2009 Software & Services Industry) , http://www.forbes.com/lists/2009/18/global-09_The-Global-2000-Software-Services_9Rank.html

Posted by arminfields

Filed in CTSH, EPS, Estimating EPS, SSG ·Tags: SSG, CTSH, Estimating EPS

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November 18, 2009

[To Read Any Post from 2009 & 2008, Just Click on the Blue Title]

2009:

- Contemplating Cognizant (CTSH), November 19, 2009

- Checking Out Coach (COH), November 6, 2009

- Researching RMD (ResMed), October 16, 2009

- Measuring Medtronic (MDT), October 3, 2009

- Monitoring Microsoft (MSFT), September 19, 2009

- Flirting With Fresenius (FMS), September 9, 2009

- Pouring Over Pepsi (PEP), August 30, 2009

- Projecting Growth at Patterson (PDCO), August 18, 2009

- Determining What’s Reasonable and What’s Not: An Update, July 15, 2009

- Considering Costco (COST), July 2, 2009

- Banking on Bard (BCR), June 19, 2009

- Gauging Growth at Gilead (GILD), June 1, 2009

- Discovering Danaher (DHR), May 22, 2009

- Investigating Industry Info , May 8, 2009

- Analyzing Amedisys (AMED) and Mulling Over More Methods, April 11, 2009

- Pondering the Preferred Procedure, March 28, 2009

- Studying Stryker (SYK), Part 2, March 16, 2009

- Boning-Up on Buckle (BKE), March 11, 2009

- Estimating EPS , March 5, 2009

- Quantifying Quality Systems (QSII), February 15, 2009

- Studying Stryker (SYK) and Mulling Over Methods, January 31, 2009

- Grappling With Grainger (GWW), January 23, 2009

- Zeroing-In On Zebra (ZBRA), January 7, 2009

2008:

- Figuring-Out Fastenal (FAST), December 31, 2008

- Monitoring Microsoft (MSFT), December 26, 2008

- Oogling Google (GOOG) , December 11, 2008

- Looking at Lowe’s (LOW), November 12, 2008

- Appraising Amazon.com (AMZN), November 7, 2008

- Judging Jack Henry (JKHY): a Shorty, October 24, 2008

- Assessing Ansys (ANSS), October 5, 2008

- Knowing Neogen (NEOG), September 7, 2008

- Examining EMC, September 6, 2008

- Probing the Performance of Paychex (PAYX), August 30, 2008

- Pondering POT (Potash Corp), August 27, 2008

- Determining What’s Reasonable and What’s Not, July 13, 2008

- Stryker (SYK): Looking Strong and Solid, July 3, 2008

- Gambling on Garmin (GRMN), June 2, 2008

- Workshop on Comparing SSGs for Staples, Procter & Gamble, Colgate-Palmolive, and CVS Caremark, May 30, 2008

- Understanding UEIC, February 21, 2008

- Figuring Out FactSet (FDS), February 4, 2008

- All About SSGs, January 20, 2008

- Analyzing Apple (AAPL), January 9, 2008

2007:

- Investigating Infosys (INFY), October 18, 2007

- Savoring Starbucks (SBUX): Molto Grande Growth, September 8, 2007

- Coach (COH): Better Investing’s Growth Company for the Year 2007, September 3, 2007

- Oracle Corp (ORCL): Another BI Stock To Study, May 13, 2007

- Peering into PRAA (Portfolio Recovery Associates), May 7, 2007

- Wondering About Wyeth (WYE), a Major Pharma, April 8, 2007

2006:

- Comparing SSGs for Walgreen (WAG), December 25, 2006

- Ceradyne (CRDN): Growth Company of the Year 2006, November 20, 2006

- UNH Follow-up: Greed and Wrongdoing Become Public, October 15, 2006

- Considering Kohl’s (KSS) and Reconsidering NAIC’s Preferred Procedure, September 13, 2006

- Two Small Company Stocks: Cognizant Technology Solutions (CTSH) and Jack Henry and Associates (JKHY), September 5, 2006

- ShuffleMaster (SHFL): A Small Company Stock, August 17, 2006

- Red-Flag Warning Signs at Cardinal Health (CAH), August 8, 2006

- GameStop Corp (GME): The Stock To Study for September, August 4, 2006

- Analyzing Amgin (AMGN), July 30, 2006

- Something’s Seriously Wrong at UnitedHealth Plan (UNH), July 21, 2006

- Comparing SSGs for Johnson and Johnson (JNJ), July 13, 2006

- Declining Growth Rates at JNJ Are Troubling, July 12, 2006

- What Are The SSG and PERT-A?, July 11, 2006

Posted by arminfields

Filed in EPS, Estimating EPS, Preferred Procedure, SSG ·Tags: Estimating EPS, Preferred Procedure, SSG

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Checking Out Coach (COH)

November 5, 2009

- Coach (COH) designs, makes and sells luxury apparel, primarily expensive women’s handbags, and has been hard hit by our current recession. My software’s PERT-A shows steadily declining EPS growth for the last 8 consecutive quarters with COH’s worst performance in the last quarter (ending 9-30-09) at -8.1% EPS, worse than its -6.8% in the prior quarter.

- However COH’s stock price has gained 60% in the last 12 months (from around $12 per share to $33), some 35% in the last 6 months, and almost nothing in the last month.

- Is Coach a good SSG Buy at this time which means, to SSGers, is it a good growth company that is selling at a good price? Let’s see.

Company Background:

- According to Wikinvest and COH’s latest Annual Report, the company operates in two segments: Direct-to-Consumer that consists of Coach-operated retail stores in North America, Japan, Hong Kong, Macau, and mainland China (84% of FY 2009 sales); and the Indirect segment that includes twp units, United States Wholesale and Coach International, both of which supply department stores and other authorized retailers.

** Women’s handbags are the company’s main driver of sales even though Coach has been trying to diversify its product lines. Handbags have gone from 65% of sales in FY 2006 to 62% in FY 2009 while accessories have increased from 28 to 29% and all other products also have increased from 7 to 9%.

** In addition to product diversification, Coach has several other plans to spur future growth:

>> a new ultra-luxury division that will sell expensive apparel in a small number of independent boutiques, not in Coach stores;

>> a new Poppy collection that is targeted to younger women which, in Q1 FY 2010, increased the company’s sales by 1%;

>> aggressive expansion into China, to capitalize on the emergence of its growing middle class, with plans to open 50 retail stores in the next 5 years and increase its market share from 3 to 10%.

- Coach has 330 full price stores and 111 factory stores in North America, 155 stores in Japan, and 128 stores in other parts of the Far East.

- Two years ago, COH was BI’s Growth Company of the year. At that time it was selling for $44.53 per share and looked like a SSG Buy to me. See: Coach (COH): Better Investing’s Growth Company for the Year 2007, September 3, 2007

Company Financials:

- Value Line rated Coach an “A” for Financial Strength with $800 M in cash assets and only $25 M in debt. Morningstar held that Coach was in “excellent” financial health with little debt and the ability to turn about 20% of its sales into free cash flow.

- The super-duper Annual Report spreadsheet by Bob Adams gave Coach’s 2009 A.R a 44 out of 100 with 9 Bullish and 9 Bearish results:

** The Bullish-good things included increasing sales and they are increasing faster than cash flow, reasonable debt to equity, and good return on free cash flow. The Bearish not-so-goods included increasing accounts receivable and inventories, the cost of sales increasing faster than sales, and free cash flow less than sales growth;

** You can get this free spreadsheet and an explanation of its many features by going to my Favorite Links page: click here.

- In April 2009, the Coach Board voted to initiate a cash dividend of $0.30 per share.

Discussion:

- Here’s a table comparing P.V.’s SSG, which I got from the BI First Cut page, with two of mine and with Take Stock. The only difference between my two SSGs is that Armin-1 uses S&P data from the Better Investing website while Armin-2 uses Hemscott-Morningstar data from the StockCentral website.

- After the table, I discuss issues identified by the comparison.

Coach (COH)	P.V.	Armin-1	Armin-2	Take Stock
Date	10-21-09	10-29-09	Same	Same
Data	S&P	*S&P*	*Morningstar- Hemscott*	Same
Price	$33.14	$32.87	Same	$31.83
52 week High & Low Price	$35.47 & $11.41	Same & Same	Same & Same	Not Included
Last Quarter of Reported Data	Q1 ending 9-30-09	Same	*Q4 ending 6-30-09*	*Same*
Software Used	TK 5	Same	Same	Online TS

Project Growth From End of	Last FY	Last Q	Same	Last FY
Sales Growth	12.00%	13.00%	Same	*01.50%*
EPS Growth	15.40%	13.00%	Same	*-10.80%*
High PE	27.0	21.1 (3 yrs out)	21.5 (Same)	25.2
High EPS	$3.91	$3.54	$3.53	$1.88
*High Price*	*$105.60* *(78% > VL as of 8-7-09)*	$74.70 (25% > VL)	*$75.90 (27% > VL)*	*$27.21 (15% < current price*
*Value Line Estimated High Price =$40-60 as of 8-7-09 and $45-65 as of 11-6-09***
L ow PE	11.0	8.6 (3 yrs out)	8.7 (Same)	10.2
Low EPS	$1.92	Same	$1.91	$1.91
Low Price	$15.00 (“other” option)	$16.50 (low PE x low EPS option)	$16.60 (Same)	$19.48
Upside/Down	4.0	2.6	1.7	*Impossible to Calculate*
Total Return	26.6%	17.8%	13.1%	*-02.8%*

SSG Buy Under	Not Available	$36.05	$27.55	$13.78
RV/PRV	82.4/71.2 (no outs)	114.8/101.7 (3 yrs out)	113.9/105.5 (Same)	Not Included
RV/PRV(no outs)	82.4/71.2	81.4/72.1		Not Included
Quality	Not Available	S&P = B+	Hemscott = Not Included	*1.10 (unacceptable)*

PTPM – 5 yr ave	36.7% Trend down	Same Same	36.2% Same	Same Trend N/A
ROE – 5 yr ave End Equity	38.0% Trend down	Same Same	38.6% Same	Not Included
ROE – 5 yr ave Start Equity	Not Available	45.9% Trend down	46.5% Same	Same Trend N/A
Debt to Equity – 5 yr ave	Not Available	0.5% Trend up	Same Same	Not Included

Estimating Future EPS Growth:

(1) P.V. used the BI/NAIC Preferred Procedure to estimate 15.40% EPS and wrote that unidentified analysts were estimating 15.30% which I did not find.

(2) I now check seven different analysts (up from six) for their long-term EPS estimates which averaged 13.71% for Coach with FactSet via Morningstar.com (the new source) high at 15.60% and Value Line low at 7.50%. Thomson Reuters via YahooFinance was 13.08%, Reuters.com was 14.35%, S&P and FactSet CallStreet via CNN Money were both 15.00%, and Zacks.com was 15.41%.

** The 9 analysts at FactSet CallStreet via CNN Money ranged from a low of 8.00% to a high of 25.00% as did the 11 analysts at Reuters.

** Value Line’s estimate of 7.50% looks like an outlier so the average without VL is 14.74% [VL’s 7.50% estimate remained unchanged in its 11-6-09 report]. That average less 1 Standard Deviation is 13.82% and less 2 SDs is 12.90%.

** I decided to use 13.00% (12.90% rounded) and thought that the 8.00% low estimates at CNN Money and at Reuters as well as VL’s 7.50% were too low compared to the other estimates. My estimate is conservative based on the average without VL less 2 SDs. Unlike PV, whose estimate was optimistic, I saw no turn-around in COH’s declining EPS growth or any other ground to be optimistic.

** For how I estimate EPS for all my SSGs, see Estimating EPS which I have updated to include the new source, FactSet via Morningstar.com.

(3) Take Stock estimated -10.8% (that’s a negative 10.8%) EPS growth for the next 5 years which seems way, way unreliable, untrustworthy and unreasonable compared to the other estimates.

Forecast High Price:

(1) P’s 27.0 Forecast High PE (times) his $2.70 Estimated High EPS (equaled) his $105.60 Forecast High Price which was a whopping 78% greater than Value Line’s High Price estimate of $40-60.

** That’s way too much for me!! See: Determining What’s Reasonable and What’s Not: An Update.

(2) My 21.1 Forecast High PE (2005-06-07 eliminated as outliers) x my $3.54 Estimated High EPS = my $74.70 Forecast High Price which was 25% greater than VL’s estimate.

** Usually, I don’t like to exceed Value Line by such a la.rge amount, but I thought VL’s estimates were low-balls, especially its 7.50% EPS estimate.

** Just as importantly, I still did not satisfy the SSG Buy criteria despite my high Forecast High Price as my 2.6 Upside/Downside Ratio was below the 3.0 requirement.

(3) Take Stock got a $27.21 Forecast High Price in the next 5 years which was less than Coach’s current price of $31.83. Bizarre! Implausible!! Unbelievable!!!

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

(1) P did not address the down trends in Coach’s PTPM and ROE, although he did find that COH’s 5-year averages were better than the averages for what he called the Apparel Industry.

(2) I found that S&P places Coach in the Textile – Apparel & Luxury Goods Industry and that COH was much better than those Industry Averages, although my industry numbers were somewhat lower than P’s.

(3) I also found that Hemscott-Morningstar places Coach in the Apparel, Accessories & Luxury Goods Industry where COH is also much better than its Industry Averages ranking #2 out of 24 companies for both PTPM and ROE.

** While Take Stock uses Hemscott data, TS sadly does not make industry comparisons.

Final Results:

(1) P.V. satisfied the SSG Buy criteria (a minimum 3.0 Upside/Downside and 15% Total Return) with a 4.0 U/D and a 26.6% TR. However, to do so, his Forecast High Price exceeded Value Line’s estimate by a enormous 78%.

** Any SSG can be prepared that satisfies the Buy criteria if we are not concerned with using reasonable judgments. Just claiming “This or that seems reasonable” is not adequate.

(2) Armin-1 and Armin-2 did not satisfy the SSG Buy criteria as both got a U/D under the minimum 3.0 criteria even though my Forecast High Price was 25% greater than VL’s estimate with S&P data and 27% greater with Hemscott data.

(3) Take Stock got a -2.8% Total Return (that’s a negative 2.8%) and deliberately does not use the Upside/Downside concept.

** Take Stock’s analysis was doomed from the start when it began with a -10.8% (that’s a negative 10.8%) EPS estimate. As a result, its Forecast High Price was less than its current price which makes it impossible even impute any U/D.

** Lastly, a Forecast High Price that is low, and that is lower than the stock’s current price, is absurd in my judgment.

-Armin

Posted by arminfields

Filed in COH, EPS, Estimating EPS, PTPM. ROE, SSG ·Tags: COH, EPS, Estimating EPS, SSG

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Researching RMD (ResMed)

October 16, 2009

ResMed (RMD) manufactures medical devices to treat and manage sleep-disordered breathing, primarily sleep apnea. RMD’s latest Investor Update explains that Q4 2009 is the 58^th consecutive quarter of revenue growth for the company.

Company Background:

- ResMed’s primary focus is sleep apnea which occurs when a person’s airway temporarily collapses while asleep, therby restricting breathing and interrupting their sleep repeatedly throughout the night. RMD’s products include airflow generators and breathing masks that introduce the airflow and pressure needed to prop open the respiratory pathway during sleep.

- According to its 2009 10-K Report, ResMed estimates that its global market is $2.5 Billion which is less than 10% penetrated. In the U.S., RMD estimates 40 million people, about one in five adults, have some form of sleep apnea with less than 10% diagnosed or treated.

- RMD’s 10-K mentions studies that show sleep-disordered breathing is present in about 80% of patients with drug-resistant hypertension, 72% of patients with Type 2 diabetes, and some 80% of patients with congestive heart failure.

- In March 2008, The Center for Medicare and Medicaid as well as Aetna Insurance approved home testing to diagnose patients with sleep-disordered breathing which RMD sees as a major opportunity for growth.

- Morningstar reports that ResMed was the second company to enter its field (Respironics, now part of Phillips Electronics, was first) and that RMD has had to differentiate itself with technically superior products which have tended to make patients more comfortable and loyal.

** As of June 2009, RMD had 2100 patents and 1100 design registrations granted or pending; in FY 2009, it invested 7% of its revenues (about $63.1 Million) in research & product development according to its lastest 10-K.

- Morningstar was unhappy with the perks and compensation given to RMD’s Chairman and other executives, such as: personal use of company aircraft; club memberships; and very expensive cars. Also, the Chairman received $2.8 M in compensation last year after stepping down as CEO.

- The one-click Annual Report spreadsheet by Bob Adams gives RMD’s 2009 A.R. a 68 out of 100 with 17 green flags, 12 caution flags, 1 red flag, 8 Bullish results and 8 Bearish results.

** The Bullish-good things include increasing sales that are also increasing faster than the cost of sales; growing gross profit margin; good return on free cash flow. The Bearish-not so goods include inadequate return on equity; return on assets should be higher; increasing accounts receivable. The one red flag is that the price to sales ratio is high.

** You can get this super-duper spreadsheet and an explanation of its many features by going to my Favorite Links page and scrolling down: click here.

Discussion:

The table below compares the SSG by CarolT, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock. The only difference between Armin-1 and Armin-2 is that they use different EPS estimates (13.00% and 16.00%). After the table, I discuss issues identified by the comparison.

ResMed (RMD)	CarolT	Armin-1	Armin-2	Take Stock
Date	9-28-09	10-5-09	Same	Same
Data	S&P	Same	Same	Hemscott-Morningstar
Price	$44.00	$43.18	Same	Same
52 week High & Low Price	$44.65 & $28.90	Same & Same	Same & Same	Not Included
Last Q of Reported Data	Q4 ending 6-30-09	Same	Same	Same
Software Used	TK 6	TK 5	Same	TS Online

Project Growth From End of	Last Q	Same	Same	Last FY
Sales Growth	15.00%	13.00%	Same	10.00%
EPS Growth	15.00%	*13.00%*	*16.00%*	10.00% initial 08.34% final
High PE	26.0 (2009, lowest in last 5 yrs)	25.0	Same	30.0
High EPS	$3.90	$3.57	$4.07	$2.88
High Price	$101.40 (12% > VL)	$89.20	$101.80 (12% > VL)	$86.53
*Value Line Estimated High Price =* *$70-90 as of 8-28-09*
Low PE	15.0 (2009, lowest in last 5 yrs)	Same	Same	18.5
Low EPS	$1.93 (TTM)	Same	Same	$1.92
Low Price	$28.90	Same	Same	$35.52
Upside/Down	3.6	3.2	4.1	5.7 (imputed)
Total Return	17.9%	15.6%	18.7%	14.9%

SSG Buy Under	N/A	$43.98	$47.13	$43.27
RV/PRV	80.2/69.8 (no outliers)	94.9/83.9 (3 yrs out)	Same/81.7 (Same)	Not Included
RV/PRV (no outs)	80.2/69.8	77.8/68.7	Same/67.0	Not Included
Quality	N/A	B+	Same	3.2 (unacceptable)

PTPM – 5 yr ave	22.3% Trend even	Same Same	Same Same	20.7% Trend N/I
ROE – 5 yr ave Ending Equity	12.5% Trend up	Same Same	Same Same	Not Included
ROE – 5 yr ave Starting Equity	N/A	15.4% Trend down	Same Same	13.7% Trend N/I
Debt to Equity – 5 yr ave	10.9% Trend down	Same Same	Same Same	N/I

Estimating Sales Growth:

- RMD’s Sales growth has been trending down from 22.8% five years ago to 15.1% three years ago to 10.2% last year. Sales growth dropped to 7.1% in the last quarter.

- Morningstar estimated 14.00% Sales growth for RMD through FY 2013 while Zacks estimated a whopping and unbelievable 22.87% for the next 5 years.

- CarolT estimated 15.00% which became important because she decided to use it as an upper limit for her EPS estimate.

Estimating EPS:

(A) CarolT’s SSG

- Carol checked EPS estimates from Value Line and NASDAQ which, when I looked, were estimating 15.00% and 19.00% for long-term EPS.

- She decided to estimate 15.00%, the same as her estimate of Sales growth for the next five years. Carol wrote: << Matching the sales growth at 15% seemed reasonable. >>

(B) Armin’s SSG-1 and SSG-2

- When I did my SSGs, the six different analysts I always check were estimating long-term EPS at an average of 16.81% with Reuters.com high at 21.00% and YahooFinance low at 11.87%. FactSet CallStreet via CNN Money.com was 16.00%, Zacks.com was 18.00%, and S&P was 19.00%.

- FactSet’s 4 analysts ranged from a high of 32.00% to a low of 16.00%; Reuters’ 5 analysts also ranged from a high of 32.00% to a low of 16.00%.

- YahooFinance’s 11.87% looks like an outlier and the average becomes 17.80% after I disregard it. That average less 1 Standard Deviation = 15.41% and less 2 SDs = 13.03%.

- Because relatively few analysts contributed to these consensus estimates, and because they varied substantially (SD = 2.39 without Yahoo, 3.23 with), I decided to estimate 13.00% EPS (the average without Yahoo less 2 SDs) for Armin-1. For Armin-2, I used 16.00%, the lowest EPS estimate by FactSet and by Reuters.

- For a more thorough discussion of how I estimate EPS, see: Estimating EPS

(C) Take Stock

- Take Stock initially estimated 10.00% EPS which, like Carol, was limited by its Sales growth estimate. Then, Take Stock lowered it to 8.34% based on its Business Model which is another name for the NAIC/BI Preferred Procedure.

- Here, Take Stock’s 8.34% estimate seems patently unreasonable compared to the average of the 13.03% from 5 analysts less 2 SDs. Even the average less 3 SDs (10.64%) is way greater than Take Stock’s EPS. For how to determine what’s reasonable and what’s not, see: Determining What’s Reasonable and What’s Not: An Update

Pre-Tax Profit Margin (PTPM) & Return on Equity (ROE):

(A) PTPM

- With S&P data, RMD is much better than its industry average in terms of its 5 year average Pre-Tax Profit Margin (22.30% vs 16.48, Health Care Equipment industry).

- Moreover, RMD’s trend is even (a down trend would be a red flag warning sign, but not an even trend).

(B) ROE

- Carol expressed concern that ResMed’s average ROE was low compared to other companies in its industry which ranged, she wrote, from the low teens to the low twenties.

- With S&P data, I found that RMD’s average of 12.5% was only slightly below its industry average of 13.7%. However, the industry average was somewhat distorted by Kinetic Concepts (KCI) with a 5 year average ROE of 62.7%.

- More importantly, ResMed’s ROE is currently trending up!

- Carol poses a difficult question to answer because the industry data available to the public is so limited and confusing:

** The S&P data used by the Online SSG at the Better Investing website places RMD in a different industry (Electromedical & Electrotherapeutic Apparatus Manufacturing) than the S&P data subscription I get from BI (Health Care Equipment). That discrepancy seems nuts to me;

** The 13.7% ROE industry average I found was from the Mid-Michigan BI Chapter which posts S&P industry data on its website, but the Online SSG with its different S&P industry for RMD shows a 15.82% ROE industry average.

** Unlike the Hemscott data at the Stock Central website, none of the S&P data is broken down by company so outliers that distort the average cannot be identified.

Final Results:

- Carol got a SSG Buy with a 3.6 Upside/Downside Ratio and a 17.7% Total Return. The NAIC/BI Buy criteria are a minimum 3.0 U/D and a 15.0% TR.

- Both Armin-1 and Armin-2 also satisfied the SSG Buy criteria. Armin-1 with its 13.00% EPS estimate is a conservative SSG while Armin-2 is more optimistic.

- Armin

Posted by arminfields

Filed in Estimating EPS, RMD, SSG ·Tags: SSG, EPS, Estimating EPS, RMD

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Measuring Medtronic (MDT)

October 3, 2009

[AF addendum: Jay P's SSG and First Cut write-up, discussed below, are also summarized in the December 2009 issue of Better Investing magazine]

- Medtronic is the world’s largest medical technology company with FY 2009 revenues of $14,599 B, up a satisfying 8%. MDT operates in seven segments: Cardiac Rhythm Disease Management (34% of FY 09 revenues: pace-makers and implantable defibrillators); Spinal (23%: artificial spinal discs); Cardiovascular (17%: heart valves, stents); Neuromodulation, (10%: implantable stimulation devices); Diabetes (8%: insulin pumps), Surgical Technologies (6%); and Physio-Control (2%: defibrillators for hospitals and public access).

Company Background:

- MDT is a global company that manufactures and sells its devices in more than 120 countries. Its primary products include those for cardiac rhythm disorders, cardiovascular disease, neurological disorders, spinal conditions and musculoskeletal trauma, urological and digestive disorders, diabetes, and ear, nose and throat conditions.

- Morningstar reports that Medtronic has successfully expanded its business away from MDT’s traditional reliance on heart disease and is now developing products for a wide variety of chronic diseases. Revenues from investments in neuromodulation, diabetes, and spinal products have increased from 25% of total sales in FY 2000 to 41% in FY 2009.

- Significant future growth is expected in three areas: MDT’s spinal bone graft product, one-of-a-kind in its market, and from atrial fibrillation and transcatheter heart valves.

- The one-click Annual Report spreadsheet by Bob Adams gives MDT’s 2009 A.R. a 55 out of 100 with 16 green flags, 2 red flags, 10 Bullish results and 8 Bearish results.

** The Bullish-good things include increasing sales that are also increasing faster than related costs; growing gross profit margin; good free cash flow. The Bearish-not so goods include increasing inventories and shares outstanding; and high debt to equity which is also one of the red flags.

** You can get this super-duper spreadsheet and an explanation of its many features by going to my Favorite Links page and scrolling down: click here.

- Legal matters:

** MDT just paid $442 M to settle a long-standing patent lawsuit involving drug coated stents that substantially reduced its 1Q earnings;

** The FDA, in July 2008, issued a warning letter to doctors regarding MDT’s Infuse Bone Graft product and reports of life-threatening complications from unapproved use;

** MDT’s latest Annual Report mentions that it incurred four litigation charges in 2009 totaling $714 M, all of which involved patent or royalty disputes.

** MDT’s A.R. also mentions that some 1250 personal injury lawsuits are pending, including 37 class actions, involving the company’s Sprint Fidelis defibrillator leads which it recalled in 2007. Wikipedia explained these leads sometimes malfunctioned and were implicated in several deaths.

Discussion:

- The following table compares the SSG by JayP, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock. Armin-1 uses S&P data from the Better Investing while Armin-2 uses the same judgments, but with Hemscott-Morningstar data from Stock Central.

Medtronic (MDT)	JayP	Armin-1	Armin-2	Take Stock
Date	9-21-09	9-23-09	Same	Same
Data	S&P	S&P	Hemscott-Morningstar	Same
Price	$37.48	$37.04	Same	$37.35
52 week High & Low Price	$54.02 & $24.86	$52.97 & Same	Same	Not Included
Last Q of Reported Data	Q1 ending 7-31-09	Same	Same	Same
Software Used	TK 5	Same	Same	TS Online

Project Growth From End of	Last Q	Same	Same	Last FY
Sales Growth	08.00%	10.00%	Same	07.90%
EPS Growth	09.00%	10.00%	Same	07.90%
High PE	21.8 (last 3 yr ave)	20.4 (2008)	17.8 (2008)	23.1
High EPS	$4.31	$4.56	$5.12	$4.65
High Price	$94.00	$93.00	$91.10	$107.19
*Value Line Estimated High Price =* *$80-100 as of 8-24-09*
Low PE	14.4 (last 3 yr ave)	08.6 (2008)	07.7 (2008)	17.3
Low EPS	$2.80 (last FY)	$2.83 (TTM)	$3.22 (TTM)	$3.22
Low Price	$24.10 (recent severe low)	$22.20 (60% x current price)	Same	*$55.71 (higher than current price)*
Upside/Down	4.2	3.8	3.6	*impossible to calculate*
Total Return	21.1%	21.1%	20.8%	25.5%

SSG Buy Under	N/A	$39.92	$39.43	$58.51
RV/PRV	72.9/67.1 (2004 & 2005 out)	72.4/65.7 (Same)	56.7/51.5	Not Included
Quality	N/A	A-	Not Included	*3.2 (unacceptable)*

PTPM – 5 yr ave	30.0% Trend down	Same Same	30.5 Same	Same Trend N/I
ROE – 5 yr ave End Equity	24.7% Trend even	Same Same	26.2% Trend up	Not Included
ROE – 5 yr ave Start Equity	N/A	26.9% Trend even	28.5% Trend up	Same Trend N/I
Debt to Equity – 5 yr ave	N/A	46.1% Trend up	45.2% Trend up	Not Included

Estimating EPS:

- Jay estimated 9.00% EPS and his First Cut write-up says that it was “in line” with Value Line and with 25 analysts who follow MDT.

** VL was actually estimating 10.00% and the 25 analysts were not identified nor were there estimates revealed. The MDT website lists 18 analysts who follow the company, but no estimates are set forth.

- When I did my SSG on 9-23-09, the six analysts I always check were closely estimating long-term EPS at an average of 10.43% with FactSet CallStreet via CNNMoney.com high at 11.00% and Value Line low at 10.00%. Thomson-Reuters via YahooFinance.com was 10.23%, Zacks.com was 10.31%, S&P was 10.40%, and Reuters.com was 10.62%.

** I had SSGed MDT on 8-24 and only FactSet and Value Line remained the same. The average then was 11.04% with S&P the largest reduction from 13.40 to 10.40% and the others going down only slightly.

** I continued to estimate 10.00% EPS which was the lowest estimate of the six by VL.

Forecast High PE:

- Jay eliminated 2004 & 2005 as outliers and used the resulting three-year average of 21.8 as his Forecast High PE.

- I also eliminated those two outliers, but saw that the trend was downward so I used 2008 (20.4, the lowest in the last 5 years) as my Forecast High PE.

- Take Stock is not programmed to look for trends and always eliminates the five highest High PEs in the last 10 years and uses the resulting average (23.1) as its Forecast High PE. This is equivalent to the Alt-M command in TK 5 and TK 6.

Forecast High Price:

- Take Stock at $107.19 was the only analysis to exceed Value Line’s estimated High Price of $80-100.

- I never want to substantially exceed VL and Take Stock’s 7% excess doesn’t seem unreasonably high to me. For how I determine if SSG judgments are reasonable, see: Determining What’s Reasonable and What’s Not: An Update

Forecast Low Price:

- Jay used MDT’s recent severe low price of $24.10 while I used $22.20, 60% of MDT’s current price.

- Take Stock, on the other hand, got a much, much higher Forecast Low Price of $55.71 which substantially exceeded MDT’s current price of $37.35.

** While this is a SSG NO-NO according to the BI/NAIC SSG Manual, this is one of several issues where Take Stock is deliberately designed to be different.

** I think it’s absurd to have a Low Price that’s high, especially when it exceeds the stock’s current price, and constitutes a serious defect in my judgment.

Pre-Tax Profit Margin:

- MDT’s Pre-Tax Profit Margin is trending down, which Jay did not mention, and which is usually a red-flag warning sign to consider abandoning the SSG.

- However, using S&P data, MDT is way better than its industry average (30.0% vs 16.4%, Health Care Equipment industry) and also way better with Hemscott data (30.5% vs 16.6%, Medical Appliances & Equipment industry). Moreover, MDT ranks 8 out of 118 companies with Hemscott data. Soooooo, I would not cease any analysis because of MDT’s PTPM trend.

- To learn more about using Industry Info, see: Investigating Industry Info

Quality:

- S&P gave MDT an A- for quality (which doesn’t show on Jay’s PDF copy) while Hemscott has no quality rating. S&P uses an eight-point scale with A+ the highest score.

- Take Stock rated MDT a 3.2 which is unacceptable as 3.4 is the minimum required to pass muster and 6.7 is desired.

Final Results:

- Jay and my two SSGs are very close: all got a Total Return of around 21% as well as an Upside/Downside Ratio of between 3.6 and 4.2. A TR > 15% and a U/D >3.0 means that MDT is a SSG Buy.

- Take Stock’s Forecast Low Price exceeded MDT’s current price which meant that it was impossible to calculate and compare our U/Ds. Take Stock also gave MDT an unacceptable quality rating while S&P gave it an A-.

Final Thoughts: [Addendum]

- While the SSG does not ask about legal issues, they can influence whether we make optimistic or pessimistic judgments, and also whether we Buy, Hold or even Sell the stock.

- Medtronic and other medical equipment makers (like Stryker and Zimmer) are in a risky business: bad news about patient injuries, governmental investigations, and/or new class actions can cause the stock price to plummet.

- Armin

[Please let me know what you think about this post by leaving a comment below and/or using the easy-to-use mouse-over star rating at the top.

*** By the way, I've added links to my Table of Contents located in the Blog's "Home" page in order to make navigation easier.]

Posted by arminfields

Filed in EPS, Estimating EPS, MDT, SSG ·Tags: EPS, MDT, SSG

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Monitoring Microsoft (MSFT)

September 19, 2009

Microsoft is the world’s largest software company (based on revenues) and about 80% of its revenue comes from sales of its Windows, Office and Server & Tools software. However, cloud computing, sometimes called “Software as a Service” (SaaS) is a direct and serious challenge. As a response, Microsoft’s newest version of Office, now in early testing, will offer online versions of Word, Excel, and PowerPoint that can be used on a computer, Web browser, or mobile phone.

MSFT was the Online Stock Study at the Better Investing website for September that was led by Jim Thomas. Jim is a director and volunteer educator with the Puget Sound chapter, a software engineer who used to work for Microsoft, and was recently appointed to the board of IClubCentral. Thanks Jim for volunteering.

Each month, the Online Stock Study completes a SSG in about one hour with the judgments made by the online participants using consensus decision-making. The Consensus SSG, Jim’s presentation slides, and the Value Line report are all available to BI members for downloading. The recorded session should be available sometime soon. [AF: it took one month, but the recording finally became available for downloading on 10-6-09]

Jim used the Online SSG which is much more limited than our SSG software. Among its many limitations, the Online SSG projects future growth only from the last Fiscal Year, ignores Relative Value & Projected Relative Value and provides only one method to decide the Forecast Low Price in the next 5 years.

COMPANY BACKGROUND:

- Jim gave a very thorough report on Microsoft’s operations: 95,000 FT employees, 60% in U.S.; 5,000 to be let go by FY 2010; new products include Windows 7 and Office 2010.

- 32% of FY 2009 revenue generated by MSFT’s Business division, 90% from sales of MS Office and 80% of that from sales to business; 25% of revenue from its Client division, 80% from Windows Vista pre-installed on PCs; 24% of revenue from its Service and Tools division, 50% from multi-year licensing agreements; 13% from its Entertainment & Devices division (Xbox, Zune, mice & keyboards); and 5% from its On-Line Services (BING, MSN, Windows Live).

- R&D spending 15% of FY 09 revenue, up from 14% in each of prior two years; revenue down 3% in FY 09, EPS down 13%.

- Jim also reported on: revenue by operating unit and by geographic area; long-term debt; share buy-backs; and dividends.

DISCUSSION:

- I analyzed MSFT previously (on 9-30-08 and 11-21-08) and compared my two SSGs to AnnC’s and to Take Stock; if you’re interested, see: Monitoring Microsoft

- In the table below, I compare the Consensus SSG to two of mine and to Take Stock. Armin-1 is my SSG as of 8-18-09, before the Online Stock Study, while Armin-2 reflects my updated SSG. Following the table, I discuss issues highlighted by the comparison.

MICROSOFT (MSFT)	Consensus SSG	Armin-1	Armin-2	Take Stock
Date	9-8-09	8-18-09	9-17-09	9-17-09
Data	S&P Online	S&P	Same	Hemscott- Mstar
Price	$24.80	$23.58	$27.66	$25.30
52 week High & Low Price	$29.74 & $14.87	$28.01 & Same	$27.66 & Same	Not Included
Last Q of Reported Data	Q ending 6-09	Same	Same	Same
Software Used	Online SSG	TK 5	Same	TS Online

Project Growth From End of	Last FY	Last Q	Same	Last FY
Sales Growth	07.80%	09.00%	Same	*-03.2*
EPS Growth	10.07%	10.00%	Same	*-11.0*
High PE	17.4	20.5 (four year ave with 2005 out)	Same	22.0
High EPS	$2.65	$2.41	Same	$0.90
High Price	$46.11	$49.40	Same	*$19.79* *(55% < VL’s low end)*
*Value Line Estimated High Price =* *$45-50 as of 8-21-09*
Low PE	09.1	14.0 (four year ave with 2005 out)	Same	15.8
Low EPS	$1.64 (last FY EPS)	$1.65 (ttm EPS)	Same	$1.62
Low Price	$14.92 (low PE x low EPS)	$17.70 (70% of current price)	Same	*$25.60* *(higher than current price)*

*Ave % Payout*	*27.00%*(reduced from 78.7%)	*26.9%* (four year ave with 2005 out)	*Same*	*Not Considered*

Upside/Down	2.15	4.4	3.1	*Impossible to Calculate*
Total Return	*14.74%*	*17.3%*	*15.6%*	05.4%

SSG Buy Under	Not Included	$25.63	Same	$10.80
RV/PRV	Not Included	82.7/76.5 (2005 out)	89.0/82.2(Same)	Not Included
Quality	Not Printed	B+	Same	*.50(unacceptable)***

PTPM – 5 yr ave	41.30% Trend N/A	Same *Trend down*	Same	39.1% Trend N/A
ROE – 5 yr ave End Equity	36.97% Trend N/A	37.00% Trend even	Same	Not Included
ROE – 5 yr ave Start Equity	Not Included	35.7% Trend up	Same	35.1% Trend N/A
Debt to Equity – 5 yr ave	Not Included	01.9% Trend up	Same	Not Included

(A) THE CONSENSUS SSG:

(1) Quality

- Jim evaluated four aspects of MSFT’s quality and found that 3 were satisfactory: Sales growth at 11.9% over the past 10 years; EPS growth at 11.4%; and Pre-Tax Profit Margin stable at 34-38% [presentation slide 27, PDF page 14].

- Return on Equity merited further study, Jim concluded, but presumably was satisfactory as it was not considered a red-flag or barbed-wire fence not to cross.

- The Online SSG does not explicitly report the PTPM and ROE trends like our SSG software and Jim missed that PTPM was trending down which is typically considered a red-flag warning sign.

** However, MSFT’s 5 year average PTPM is 40.30%, some 300% better than its industry average of 13.6% using S&P data, so I’m not worried. To make this type of comparison, see: Investigating Industry Info.

(2) Estimating Sales Growth

- Jim gave the group three specific choices to estimate Microsoft’s future Sales growth: 11.9%, last 10 year historical growth; 10.0%, Value Line’s Sales per share estimate; and 7.8%, a composite rate that Jim devised (6 year historical + Yahoo Finance FY 2010 & 2011 estimates + VL FY 2012-2014 estimate) [slide 36, PDF page 18].

- He also offered two other choices that seem pointless: higher and lower.

- Jim did not consider MSFT’s more recent historical Sales Growth (6.9% and 11.4% last 3 and 5 years) and did not mention other analyst estimates for Sales growth (not Sales per share growth): Zacks at 10.62% estimated Sales growth for the next 5 years.

- The Consensus chose 7.8% which is no surprise since that seems to be the only realistic option out of the 5 choices offered.

(3) Estimating EPS Growth

- Because Jim used BI’s Online SSG, all projections were from the end of the last FY (2009, $1.64 EPS) unlike our SSG software which has options to project from the end of the last quarter or from the trend line. This had no impact on MSFT because the end of its FY was also the end of its last Q.

- Jim also gave participants three choices to determine MSFT’s future EPS growth: $2.89 or 12.0% from S&P’s estimate; $2.73 or 10.7%, another composite rate Jim derived from Yahoo Finance’s FY 2010 & 2011 estimates and VL 2012-2014 estimate; and $2.65 (no rate mentioned), next 3-5 year estimate by Value Line [slide 44, PDF page 22].

- He also offered the same two other choices: higher and lower.

- Surprisingly, Jim did not consider Yahoo Finance’s EPS estimate for the next 5 years (10.17%) which seems way more appropriate than relying on its EPS estimates for the next two years. And, while he mentioned MSFT’s historical EPS growth (11.40%), he did not offer it as an option to the group.

- Perhaps most importantly, Jim did not consider the long-term EPS estimates from other analysts which I discuss under Armin’s SSGs.

- The Consensus chose 10.7%, Jim’s composite rate.

(4) Forecasting High & Low PEs

- Jim offered three choices to Forecast MSFT’s High and Low PEs for the next 5 years: 20x & 16x, from 10% plus or minus VL’s forecast of 18x; 17.4 & 9.1, from 2009 actual; and 15x & 10x, from Jim’s “visual” inspection of the range over the last year.

- Again, he also offered the same two other choices: higher and lower.

- The Consensus chose 17.4 & 9.1, from 2009 actual.

(5) Estimating Average % Payout

- Microsoft paid a special dividend in 2005 that distorted the five-year average. So Jim reduced the 78.70% average to 27.00% in order to estimate the average % payout for the next 5 years. That is equivalent to treating 2005 as an outlier and averaging the last four years. This issue was not mentioned in the Presentation Slides.

(6) Forecast High & Low Prices, Upside/Downside Ratio and Total Return

- These also were not mentioned in the Presentation Slides.

- The Consensus did not get a SSG Buy with an Upside/Downside Ratio of 2.15 (under the 3.0 minimum criteria) and a 14.74% Total Return (under the 15.00% minimum criteria).

(B) ARMIN’S SSGs:

(1) Estimating EPS Growth

- When I did my SSG on 8-18-09, the six analysts I always check were estimating long-term EPS at an average of 10.73% with S&P high at 12.00% and Value Line low at 10.00%. At FactSet CallStreet via CNN Money.com, the Consensus was 11.00% (from 8 analysts who ranged from 13.0 to 5.0%); Zacks.com was 10.62%; Reuters.com was 10.61% (from 11 analysts who ranged from 13.0% to 7.00%); and FirstCall/Reuters via YahooFinance.com was 10.17%.

- When I updated my SSG on 9-17, only S&P had changed its estimate to 10.00% (down from 12.00%).

- I estimated 8.00% EPS both times, well under all the consensus estimates.

- Estimating EPS explains how I estimate EPS for all my SSGs.

(2) Forecasting High & Low PEs

- I eliminated 2005 as an atypical outlier and used the four-year historical average as my Forecast High & Low PEs.

- This was the major difference between my SSGs and the Consensus, and explains why both times I got a SSG Buy with Upside/Downside Ratio > 3.0 and a Total Return > than 15.00% while the Consensus did not.

(C) TAKE STOCK:

- Take Stock is a computerized, one-click program at the StockCentral website that produces an almost-SSG and is designed to generate a conservative result.

- Its EPS estimate for the next 5 years was –11.00% (that’s a minus eleven percent) which seems patently unreasonable and irrational compared to the six analysts I checked who averaged 10.72% and even to the very lowest estimate of 5.00% by one analyst at CNNMoney.

- Because of its low-ball EPS estimate, Take Stock’s Forecast High Price was $19.79, also unreasonably low and a whopping 55% below the low end of Value Line’s $45-50 High Price estimate. If you’re interested in learning how to judge the reasonableness of SSG judgments, see: Determining What’s Reasonable and What’s Not: An Update.

- Take Stock gave Microsoft a quality rating of .50 on a ten-point scale where a minimum of 3.4 is required to pass muster and 6.7 is desired. On the other hand, S&P gave MSFT a B+ quality rating.

- Armin

Posted by arminfields

Filed in Estimating EPS, MSFT, SSG ·Tags: Estimating EPS, MSFT, SSG

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Pouring Over Pepsi (PEP)

August 30, 2009

PepsiCo (PEP) has 18 global mega-brands, each with annual sales of more than $1 billion, and they include Pepsi Cola, Gatorade, Mountain Dew, Fritos, Lay’s, Doritos, Tostitos, and Quaker. Pepsi is a global beverage, snack and food company and makes a wide range of snacks, carbonated and non-carbonated beverages, and foods that it sells in some 200 countries.

Company Background

Sales in PEP’s North American beverage segment fell 7% in the second quarter of this year while Coke’s sales fell only 1% according to Morningstar. However, Pepsi’s snack food segment showed solid growth. Its North American snack business is PEP’s most profitable sector, generating 33% of its total sales and 44% of its profits. Through its Frito-Lay division, PepsiCo is the world’s largest snack food company, controlling almost 40% of the U.S. salty snack market and around 30% of the non-U.S. market.

PEP’s latest 10Q quarterly report shows that Frito-Lay is the largest of its six segments accounting for 30% of Net Revenues for the last 12 weeks and 33% for the last 24 weeks. Sales of Pepsi Cola and other beverages by the Pepsi Americas segment amounted to 25% in both periods. Bottle Case Sales, a common measure PEP uses for all of its soft drinks, declined 6% “reflecting continued softness in the North American liquid refreshment category.” (7-22-09, page 34) Worse, non-carbonated beverage volume in North America dropped 14%, primarily due to double digit declines in Gatorade sports drinks and Aquafina water.

And, PEP’s sales have declined for four consecutive quarters.

In August, PEP announced it had reached a deal to buy the outstanding shares of its two main bottlers for $7.8 billion, ending a months-long disagreement over the price. Before the deal was final, Value Line thought the purchase would contribute to long-term growth of sales and EPS. However, with declining sales of carbonated and non-carbonated soft drinks, I don’t understand what Pepsi hopes to concretely accomplish.

Below, I compare and then discuss AnnC’s SSG, which I got from BI’s First Cut page, with mine and with Take Stock.

PepsiCo (PEP)	AnnC, from BI’s First Call	Armin	Take Stock
Date	7-13-09	7-17-09	7-16-09
Data	S&P	Same	Hemscott
Price	$55.52	$56.66	$57.28
52 week High & Low Price	$72.25 & $43.78	Same & Same	Not Included
Last Quarter of Reported Data	Q1 ending 3-31-09	Same	Same
Software Used	TK 5	Same	TS Online

Project Growth From End of	*Last FY*	*Last Q*	*Last FY*
Sales Growth	6.00%	8.00%	8.50%
EPS Growth	7.00%	8.00%	*-5.1%*
High PE	20.0	21.0	22.5
High EPS	$4.85	$5.13	$2.47
High Price	$97.00	$107.20	$55.49
*Value Line Estimated High Price =* *$90-110 as of 5-1-09 and 7-31-09*
Low PE	12.0	14.4 (from 2008, lowest in last 10 years)	17.3
Low EPS	$3.49 (TTM)	Same	$3.17
Low Price	$41.90 (Low PE x Low EPS)	$43.80 (Recent Severe Low Price)	$57.28 (same as Current Price)
Upside/Down	3.00	4.0	Impossible to Calculate
Total Return	13.8%	15.6%	2.2%
Final Result	SSG HOLD	SSG BUY	DON’T BUY

SSG Buy Under	$53.00	$60.85	$31.39
RV/PRV (no outs)	77.6/72.5	79.0/73/3	Not Included
Quality	N/A	A+	2.2 (Unacceptable)

PTPM – 5 yr ave	19.3% Trend down	Same Same	18.9% Trend N/A
ROE – 5 yr ave with End Equity	33.4% Trend down	Same Same	Not Included
ROE – 5 yr ave with Start Equity	N/A	33.8% Trend down	33.9% Trend N/A
Debt to Equity – 5 yr ave	N/A	27.8% Trend up	Not Included

DISCUSSION

1. EPS Estimates:

(A) AnnC’s SSG

** Ann used the BI/NAIC Preferred Procedure to estimate 7.00% EPS growth. Her PP was based on the following five estimates: 6.00% Sales growth [less] 18.0% Pre-Tax Profit Margin (overriding the 19.3% default) [less] 26.7% Tax (default) [less] -0- Preferred Dividends (overriding the $2.0 per share default [divided by] 1556 M Shares Outstanding (default) [equals] 7.2% EPS. Ann used 7.0% EPS.

** Compared to Ann’s 6.00% expected Sales growth, Zacks.com estimated 10.17% while Morningstar Premium estimated 4.00% internal growth. However, Mstar recognized that PEP’s nearly 10.00% historical Sales growth in the last 5 years included several acquisitions and also the advantageous effects of a weak dollar.

** Unlike Ann, I no longer use the PP and think it involves too many estimates and too much guesswork. Moreover, if you start with a low estimate of Sales growth, you usually wind up with a very low EPS estimate. See: Pondering the Preferred Procedure, http://arminfields.wordpress.com/2009/03/28/pondering-the- preferred-procedure/

(B) Armin’s SSG

** When I did my SSG, the six analysts I always check were estimating long term EPS at an average of 9.775% with Zacks.com high at 11.53% and Value Line low at 8.00%. First Call via YahooFinance was 9.47%, Reuters.com was 9.65%, and S&P and FactSet CallStreet via CNN Money were both 10.00%.

** Three analysts contributed to the consensus at Reuters and ranged from 10.0% to 8.9%. The three analysts at FactSet ranged from 11.0% to 9.0%.

** I used 8.00% EPS based on Value Line’s estimate which was the lowest of all the estimates. To know which is the lowest, we must check all six.

** PEP’s historical EPS has been steadily declining for the last 5 years from 11.0% in 2004 down to 2.7% in 2008.

(C) Take Stock

** TS estimated -5.10% EPS (that’s a negative 5.10%) which was a whopping 14.80% less than the average of the six analysts and 13.10% less than VL, the lowest of the six estimates. I consider that unreasonably conservative and, once again, we need to check all six analysts to make that judgment.

2. Forecast High Prices:

** Ann’s Forecast High Price was $97.00 which was close to, but not below, the low end of VL’s $90-110 estimate.

** I got $107.70 which was close to, but not above, the high end of VL’s estimate.

** Both forecasts seem reasonable to me as my rule of thumb is to never substantially exceed or fall below VL’s estimate, at least not without a good reason. See: Determining What’s Reasonable and What’s Not: An Update, http://arminfields.wordpress.com/2009/07/15/determinung-whatsreasonable-and-whats-not-an-update/

** Take Stock’s Forecast High Price was $55.49 which was a huge 38% below the low end of VL’s $90-110 estimate and which, once again, seems unreasonable and irrational by comparison since PEP was then currently selling for $57.28.

3. Pre-Tax Profit Margin and Return on Equity

(A) PTPM

** With S&P data, which Ann and I both used, PEP’s 5-year average PTPM was 19.3% and trending down. Down trends are usually a red flag indicating poor performance. However, S&P places PepsiCo in the Soft Drinks Industry whose 5-year average PTPM was 11.6%, substantially worse than PEP.

** With Hemscott data, which Take Stock used, PEP’s average PTPM was 18.9% while its industry average, this time in the Processed and Packaged Goods Industry, was 8.1% and again substantially worse than PEP which ranked third of 61 companies (as of May 6, 2009).

(B) ROE

** With S&P data, PEP’s average ROE was 33.4%, trending up, and its industry average of 20.9% was substantially worse.

** With Hemscott data, PEP’s average ROE was 33.3% and again its industry average of 21.0% was substantially worse. PepsiCo ranked 7 out of 61 companies.

4. Final Results :

** Ann got a SSG Hold with a 3.0 Upside/Downside ratio and a 13.8% Total Return which did not satisfy the minimum 15.0% TR criteria.

** I got a SSG Buy with a 4.0 U/D and a 15.6% TR.

** Take Stock does not use the Buy, Hold or Sell criteria nor the U/D concept and it seems likely that TS would say Dump/Don’t Buy PEP.

** S&P rated PepsiCo’s quality as A+ while Take Stock rated PEP a 2.2, unacceptable.

5. Final Thoughts:

** Ann projected future growth from the last FY while I used the last Quarter. If she had projected from the last Q, her U/D would have been 3.1 (instead of 3.0) and her Total Return would have been 14.8% (instead of 13.8%). That is an almost SSG Buy and, as the FY progresses with one or two more reported quarters, is likely to be a solid SSG Buy.

** Regardless of what my SSG shows, I’m not impressed with PepsiCo.

- Armin

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Posted by arminfields

Filed in Estimating EPS, PEP, PTPM. ROE, SSG ·Tags: Estimating EPS, PEP, SSG

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Projecting Growth at Patterson (PDCO)

August 18, 2009

Mark Robinson, founder and General Manager of Manifest Investing, recently posted his SSG of Patterson Companies (PRCO) at BI’s First Cut page. Mark used several extraordinary SSG methods: he added two years of estimated annual data, source and details unknown, which extended his projection of growth for the next 7 years out to 2015.

Also, Mark’s projected High EPS shows as $2.05 of the SSGs front page, but mysteriously as $2.50 on the back. The additional estimated data changed the 5 year average and trend of PTPM as well as ROE, and also led to a projected Low Price option, Low PE x Low EPS, that was higher than the current price even after he lowered his projected Low EPS by 40%. All of this is seriously strange and decidedly questionable..

In January, I critiqued Mark’s SSG for Stryker (SYK) and his SSG methods, http://arminfields.wordpress.com/2009/01/31/studying-stryker-syk-and-mulling-over-methods/

Here, Mark has some surprises which I discuss after the following comparative table. Armin-1 uses all of Mark’s judgments except it does not add any estimated annual data. Armin-2 is identical except it uses 10.00% estimated EPS instead of Mark’s 7.00%.

Patterson Companies (PDCO)	Mark Robertson	Armin-1	Armin-2	Take Stock
Date	7-10-09	8-7-09	Same	8-11-09
Source of Historical Data	S&P	Same	Same	Hemscott/ Morning- star
Price	$21.01	$25.00	Same	$21.89
52 week High & Low Price	$33.85 & $15.75	Same & Same	Same & Same	N/A
Last Quarter of Hist Data	Q4 ending 4-30-09	Same	Same	Same
Software Used	TK 5	Same	Same	Online TS

Years of Hist Data	2001-2008	1999 -2008	Same	Same
Years of Esti-mated Data	2009 & 2010 ESTIMATED	NONE	NONE	NONE
Source of Est Data	UNKNOWN	None	Same	Same

Project Growth from	UNKNOWN	Last Q of Hist Data	Same	Last FY of Hist Data
Sales Growth	6.00%	Same	Same	2.90%
EPS Growth	7.00%	Same	10.00%	0.30%
High PE	22.0	Same	Same	25.6
High EPS	$2.50	$2.37	$2.72	$1.66
High Price	$55.00	$52.10	$59.80 (9% > VL)	$42.56
*Value Line Estimated High Price =$40-55 as of 5-29-09 and $35-45 as of 8-28-09***
Low PE	14.0	Same	Same	15.4
Low EPS	$1.75(down from $2.90)	$1.70 (TTM)	Same	$1.69
Low PE x Low EPS	$24.50 (> current price)	$23.80 *(< current price)*	Same	$26.03 (> current price)
Final Low Price	$16.00(“other” option)	Same	Same	$26.03 (> current price)
Upside/Down	6.8	3.0	3.9	Impossible to calculate
Total Return	21.2%	15.8%	19.1%	11.3%

SSG Buy Under	N/A	$25.03	$26.95	$21.28
RV/PRV (no outs)	69.9/67.3	60.5/56.6	Same/55.0	N/A
Quality	N/A	B+	Same	1.1 (un-acceptable)

PTPM – 5 yr ave	11.3% (end est 2010, trend even)	11.7% (end 2008, trend down)	Same	11.2% trend N/A
ROE – 5 yr ave End Equity	17.1% *(end est 2010, trend down)*	17.4% *(end 2008, trend even)*	Same	N/A
ROE – 5 yr ave Start Equity	N/A	19.3% (end 2008, trend up)	Same	19.3% trend N/A
Debt to Equity – 5 yr ave	N/A	30.5% (end 2008, trend up)	Same	N/A

Discussion

- Mark added two years of estimated annual data (2009 and 2010, source and details unknown) to his SSG which meant that 1999 and 2000 were eliminated because our Toolkit software only holds 10 years of data. Then, he eliminated three more years (2001, 2002, and 2003) as outliers to arrive at a 6.00% quasi-historical sales growth rate that he used as his projected sales growth for the next seven years to 2015.

- Projected sales growth is important to Mark because it is the first element of the BI/NAIC Preferred Procedure which he uses “almost exclusively” to determine his projected EPS growth. Sadly, he did not set forth the other elements of his PP (Pre-Tax Profit Margin, Tax Rate, and Shares Outstanding) which, in Mark’s case, all had to be projected for the next seven years. A simple command, Alt-R, could have set forth the PP on the SSG’s front page.

- If this scheme wasn’t convoluted enough, Mark’s High EPS shows as $2.05 on the SSG’s front page, but as $2.50 on the back page. It’s supposed to be the same so this is a serious and major discrepancy, there’s no attempt at any explanation, and Mark’s SSG cannot be replicated, at least not without the secret code.

- Mark’s PP resulted in a 7.00% EPS rate ($2.05 or maybe 2.50 estimated High EPS in 2015). Unlike Mark, I no longer use the Preferred Procedure because it involves too many estimates and too much guesswork even under normal circumstances. See: Pondering the Preferred Procedure, http://arminfields.wordpress.com/2009/03/28/pondering-the-preferred-procedure/

- In his First Call write-up, Mark insists:

“It’s not the EPS growth rate that matters. It’s the 5-year estimate for EPS [AF: in dollars] that forms the core calculation on the SSG.” He adds: “(For those of you who teeter on the precipice of a nervous breakdown over the EPS growth rate, it’d be something on the order of 7% — but get over it, it’s the 5-year EPS value that really matters and I derive that almost exclusively using the preferred procedure.)”

** Overlooking this needless hectoring, Mark’s core calculation is seriously scrambled because it shows as $2.05 on his SSG’s front page and $2.50 on the back (it’s intended to be identical);

** Moreover, at four major websites, long-term EPS estimates are expressed only as a percentage rate (and not in dollars): Reuters, CNNMoney, Zacks, and YahooFinance. Two others show an EPS estimate as a percentage rate and as a dollar amount: S&P and Value Line. No website I know of makes a long-term EPS only in dollars. See: Estimating EPS, http://arminfields.wordpress.com/2009/03/05/estimating-eps/

- Perhaps the biggest disappointment is that Mark never even tried to explain why it was necessary to add ANY estimated data since the norm is to project the next 5 years based on actual data. How did he project our current recession? Which web site did he rely on and for what data? Why two years of estimated data and not one or three years?

- Lastly, the default for the projected Low EPS is no growth at all which, for Mark’s SSG, was $2.80 estimated (entered as 2010 actual). Mark lowered this by 40% to $1.75 but, once again, offered no explnation. With 6% growth for his projected High EPS and -40% for his projected Low EPS, Mark’s growth projections seem flaky and foolish, especially adding two years of estimated annual data.

CONCLUSIONS:

(A) It turns out that every one of Mark’s machinations were unnecessary. Armin-1 duplicates all of his judgments with one exception: it does not add those two years of estimated data. We both got a SSG Buy and satisfied the minimum 3.0 Upside/Downside and the 15% Total Return criteria. Armin-1 would look even better if I used the same $21.00 price as Mark did.

(B) Mark’s 7.00% projected EPS, after his many maneuverings, is not even close to what the analysts were estimating. When I did my SSG, the six long-term EPS estimates I always check averaged 12.70% with Value Line low at 10.00% and Reuters high at 14.40%. Thomson/FirstCall via YahooFinance was 11.75%, Zacks.com was 12.67%, FactSet CallStreet via CNN Money was 13.00%, and Reuters.com was 14.40%.

** Armin-2 used 10.00% estimated EPS, the lowest of the six analysts and also satisfied the SSG Buy criteria.

(C) The substantial variation among these six long-term EPS estimates demonstrates, I think, the wisdom of not using any estimated annual data in our SSGs. Unlike actual data, you can never be certain with any estimate and one website’s estimate is no more accurate than another’s. Moreover, our SSG wants six pieces of info for each year of annual data which are tricky to estimate. Note the different trends on PTPM and ROE that Mark got with his estimated data and that I got with actual data.

(D) Whenever we share our SSGs, at a club meeting or with BI’s First Cut or at another web site, all of us should try to make clear what we did and why, especially when we do something out of the ordinary. For example, Mark added two years of estimated annual data (source and details unexplained), used the Preferred Procedure (unexplained), got a High EPS of $2.05 on the front page and $2.50 on the back (unexplained), lowered his Low EPS from $2.90 to $1.75 (unexplained), and got a Low EPS x Low PE that exceeded the current price (unexplained).

(E) I think Mark’s SSG and his unique methods are unreliable, and neither helped me understand PDCO.

What do you think?

[You can leave a comment below and/or rate this post by using the new, mouse-over star system at the top]

Armin

Posted by arminfields

Filed in Estimating EPS, PDCO, Preferred Procedure, SSG ·Tags: Estimating EPS, PDCO, Preferred Procedure, SSG

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Determining What’s Reasonable and What’s Not: An Update

July 15, 2009

[AF: In this update, I've added a substantial amount of new material, indicated in blue italics, on how to determine if our SSG Forecast High PEs and High Prices are reasonable. My original post was published on July 14, 2008 and focused on how to determine if our SSG Sales and EPS estimates* were reasonable. As always, let me know what you think.]***

Every SSG must make several judgments about the future, the most important of which is estimating the growth of earnings per share for the next 5 years. Estimating Sales growth is also important, especially when it is used to derive EPS growth as part of the BI/NAIC Preferred Procedure.

How do we determine what’s reasonable and what’s not? The answer is easy to express (by comparisons) but much more complex to explain. Consider this concrete example:

Is it reasonable to estimate 24.0% Sales growth for the next 5 years for Cognizant Technology Solutions (CTSH)? Is 21.4% EPS growth reasonable? How do we decide?

In the August 2008 issue of Better Investing magazine, guru Cy Lynch SSGed CTSH using S&P data. Cy found that Cognizant had Sales growth of 48.4% per year during the last 10 years, “the highest rate in the IT services and consulting industry.” His SSG also showed that CTSH averaged an even higher EPS growth rate, a whopping 49.6% annually, during the same 10 year period.

Moreover, over the last 5 years, CTSH’s annual growth rates actually increased to 55.3% Sales and 50.7% EPS. So what do you think is a reasonable estimate for CTSH’s future growth in the next 5 years?

Here is Cy’s answer: “…applying arbitrary limits to projected growth in your stock studies under the guise of being conservative can lead to missed opportunities. I find estimated revenue growth of 24 percent to be reasonable.” [emphasis added]

DISCUSSION

(A) Determining if our SSG Sales and EPS Estimates are Reasonable:

- Cy asserts that a 24.0% estimate for Sales growth is reasonable, but marshals no evidence to support his claim. He does say that Sales grew by an “exceptional 48.4 percent over the last 10 years,” which on its face would seem to support a substantially higher estimate. However, Cy makes no effort to explain why he is estimating so much less than the company’s historical average or why he chose 24.0%.

- For CTSH, Morningstar is estimating 32.10% Sales growth for the next 5 years and Zacks is estimating 55.66%. Cy’s 24.0% estimate is conservative by comparison even though it is greater than the 20.0% maximum advocated by some other BI gurus.

- When I looked on July 12th, the analysts were estimating long-term EPS at around 28-29% with FactSet CallStreet low at 27.00% and Zacks high at 29.86%. S&P was 28.00%, FirstCall was 28.49%, Value Line was 28.50%, and Reuters via Morningstar was 29.00%. There were six estimates at FactSet which ranged from 32.0% to 20.0% low while the seven estimates at Zacks ranged from 49.0% high to 20.0% low.

- When I looked again almost one year later on June 29, CTSH had fallen in price by -22% and the analysts had lowered their long-term EPS estimates to an average of 21.78% (down from 28.48%) with First Call low at 18.17% (down from 28.49%) and Value Line high at 28.50% (unchanged).

- Thus, 20.0% EPS is the very lowest estimate by any of these analysts and Cy’s 21.4% estimate seems conservative by comparison, especially compared to the 28-29.0% consensus analyst estimate.

- Cy derived his 21.4% estimated EPS from BI’s Preferred Procedure (PP) which involves making four estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Tax Rate, and Shares Outstanding. To get his 21.4% estimate, Cy estimated 24% Sales Growth, 19.2% PTPM, 25.0% Tax, and 300M Shares.

- Certain tax breaks that CTSH receives from the Indian government are ending and Cy’s 25% Tax Rate estimate is close to Value Line’s 24% estimate in the next 3-5 years and identical to Morningstar’s estimated long-term tax rate of 25%.

- Cy wrote that his 300M Shares Outstanding was based on VL’s estimate, but VL was actually estimating 288M Shares Outstanding as per its 5-23-08 report. If Cy had used that number, his EPS estimate would have increased from 21.4 to 22.4%.

- Cy also used a Net Profit Margin of 14.3%, but did not explain how he converted that to get the Pre-Tax Profit Margin for his PP. One way is to use this formula [NPM/ (1-Tax Rate)] which works out to 19.1% PTPM. I also worked backwards from all his other factors to get 19.2% which is a slight decrease from 2007’s 19.4% and 5-year average of 20.2%. PTPM has been trending down for the last 5 years.

(B) Determining if our SSG Forecast High PEs and High Prices are Reasonable:

- Our starting point is: High PE x High EPS = High Price. When PE trends are not obvious or I know next to nothing about the stock, I most often begin by choosing a Forecast High PE using Toolkit’s Alt-M command. Alt-M is an undocumented feature that averages the five lowest High PEs (and Low PEs) in the last 10 years. It is usually the most conservative option.

- Some SSGers like to limit their Forecast High PEs to no more than 1.5 times their EPS growth estimate which is the same as using a PEG of 1.5 while others like to use 2.0 and still others prefer 2.1776 . To me, all such limits are arbitrary and unreasonable as no one number fits all stocks. Worse, there is no authority for a 2.0, 2.5, or 2 point anything High PEG.

- What I do is compare Forecast High Prices for the next 5 years to Value Line’s Estimated High Price for the next 3-5 years. I use a two-part test: (A) Does the SSG High Price substantially exceed or fall below VL’s estimate and, if yes, (B) Do I know of a good reason that supports the SSG’s High Price. If my answer is no to (B), I most likely would revise my SSG judgments.

- You can define “substantially” any way you like as there is no right or wrong for matters of judgment. There is, of course, good and bad judgment. I consider substantial to be 15-20% per share greater (or less) than VL. I consider bad judgment to be ignoring VL. And, good reasons can come from research, reading all I can including, for sure, the company’s latest annual report.

- One nice thing about VL’s High Price estimate is that it is expressed as a range from a low of “X” to a high of “Y”. (VL’s low end is not comparable to the SSG’s Low Price). For me, VL’s estimated High Price range defines what’s reasonable, and what’s unreasonable is anything that substantially exceeds or falls below VL without a good reason.

- For example, VL was estimating a $60-90 High Price for CTSH when Cy did his SSG. I’m comfortable being at the high end of VL’s estimate because I know the company’s growth has been like a rocket ship. If I didn’t know much about the company, then I’d prefer to be at the low end of VL’s estimate.

- Cy’s SSG estimated 21.4% EPS growth for CTSH and a 29.0 Forecast High PE that resulted in a $94.50 Forecast High Price, only $4.50 per share or 5.00% more than VL which, by comparison, seems reasonable to me.

- VL makes a High Price estimate for only about 1700 stocks in its Large Cap edition. Its estimate is for the next 3-5 years which means, as I understand VL, for the next 3 and next 4 and next 5 years. That is, the same estimate is applicable to a three year period. VL’s Small and Mid-Cap edition contains no High Price estimate.

- Keep in mind that VL provides benchmark guidance and is not an iron law. What’s most important, I think, is not to overlook or ignore Value Line’s guidance.

CONCLUSIONS:

- I have two, related quarrels with Cy’s analysis:

(1) his way low Sales and EPS estimates both of which were substantially lower compared to CTSH’s historical growth and to what the analysts were estimating. Because of the way the NAIC/BI Preferred Procedure is structured, a Sales estimate that is way low results in an EPS estimate that is way, way too low; and

(2) I am not content with his unsupported assertion that a 24.0% Sales estimate is “reasonable”: simply claiming that something is appropriate does not make it so.

- I no longer use the PP because it involves too many estimates and too much guesswork for me. I prefer to survey the analysts, ascertain their long-term EPS consensus estimate, and thus learn what is high and what is low. That way, I have some basis to know what EPS estimate is reasonably in the ball park and what is not. See: Pondering the Preferred Procedure.

- Make no mistake, I emphatically agree with Cy that arbitrary limits on our SSG estimates are serious mistakes, but I also insist on having some evidence to support each judgment and any claim of reasonableness.

- Here’s a concluding example that tries to put all this together in the context of assessing the Take Stock analysis of Starbucks (SBUX):

(1) On July 1, 2009, Take Stock was estimating EPS growth for Starbucks at -19.10% for the next 5 years (that’s a negative 19.1%). That low-ball estimate works out to a TS Forecast High Price of $6.90 for the next 5 years with SBUX currently selling at $13.89.

(2) I checked the long-term EPS estimates for SBUX by six different analysts and they averaged 15.97% with S&P high at 19.00% and Value Line low at 10.5%. By comparison, -19.1% EPS growth for the next 5 years seems patently unreasonable;

(3) In contrast to Take Stock’s $6.90 Forecast High Price for SBUX, Value Line is estimating a High Price of $25-35. That means TS’s forecast is an whopping 72% UNDER the low end of VL’s estimate which again seems blatantly unreasonable by comparison.

(4) Take Stock’s Forecast Low Price ($10.01) is higher that TS’s Forecast High Price ($6.90). As a result, TS’s High Price is actually low while its Low Price is actually high. That seems way, way wacky to me.

- Armin

[Ellis Traub, the developer and defender of Take Stock, and frequent poster to the BI Discussion List, is invited to comment on what he thinks is reasonable and what's not.]

Posted by arminfields

Filed in CTSH, Estimating EPS, SBUX, SSG ·Tags: CTSH, EPS, SBUX, SSG

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Pondering the Preferred Procedure

March 28, 2009

The SSG’s Preferred Procedure is one method to estimate future EPS growth for the next 5 years. Cy Lynch, a NAIC/BI and Manifest Infesting guru, has written a series of articles in Better Investing magazine that explain the PP using Oracle Corp as an illustration. Since Oracle has no Preferred Dividends, only four estimates are needed to calculate its PP: Sales Growth, (less) Pre-Tax Profit Margin, (less) Tax Rate, (divided by) Shares Outstanding (equals) Earnings Per Share.

I have long held that the Preferred Procedure involves too many estimates and way too much guesswork. My earlier assessment is at: Considering Kohl’s (KSS) and Reconsidering NAIC’s Preferred Procedure, September 14, 2006. Oracle (ORCL) is yet another illustration that the PP is full of weak speculation.

(1) Final PP Result for Oracle: 11.30% Estimated EPS

Cy’s PP resulted in an estimated 11.30% EPS growth rate which, he says in the 3-09 issue of BI magazine, is reasonable compared to Value Line’s 11.60% estimate and the 13.40% estimate from Yahoo Finance.

(A) VL’s EPS estimate was 17.00% (not 11.60%) and is now 15.00% as of 2-20-09, VL’s latest report on ORCL. By comparison, Cy’s 11.30% EPS estimate is way low.

(B) Cy did not compare his 11.30% against other EPS estimates: 15.00% @ FactSet CallStreet via CNNMoney; 15.00% @ S&P via BI.org; 13.82% @ Zacks.com; and 13.73% @ Reuters.com. Again, Cy’s 11.30% estimate is low by comparison.

Note that these EPS estimates are from six different data sources, not just different websites, and I ALWAYS check all six for every SSG I do. Here’s a link to how I estimate EPS; see: Estimating EPS. Checking only two sources, as Cy did, is not sufficient to learn which are in the ball park and which may be out-of-whack.

(C) My method would be to stop here and use one of the following: the lowest of the six EPS estimates (13.43% currently by Thomson Reuters via YahooFinance), or the average of all six (14.33%), or the average less 1 Standard Deviation (13.65% and easily calculated by Excel).

I think these three choices are reasonably conservative and each of them “wrings-out” what many consider to be analyst over-optimism. If you were still worried, the average less 2 Standard Deviations is 12.97% which I consider a useful benchmark as anything less (like Cy’s 11.3% estimate) seems unreasonably conservative to me.

We need some criteria to tell us what’s too high as well as what’s too low!!

(2) The First PP Element: 12.00% Estimated Sales Growth for ORCL

We can see why Cy got such a low EPS estimate by examining the separate parts of his Preferred Procedure. The first element of Cy’s PP began with a 12.00% estimate of Sales growth for the next 5 years.

(A) Cy used Value Line data for his SSG and found that ORCL’s Sales growth was 9.4% over the past 10 years which, he says, was flat for the first five and increased to 22% over the following four years due to mergers.

(B) Using S&P data from BetterInvesting.org, I see that ORCL’s sales have grown 9.2% over the last 10 years, 16.0% during the last 7, 22.2% during the last 5, and 24.9% over the last 3. Mergers in 2005 and 2006 complicate using ORCL’s recent historical record to project future growth.

One approach might be to use its 16.00% sales growth over the last 7 years which is the same with S&P or VL data. Estimating 16.00% instead of Cy’s 12.00% sales growth, with no other changes in the PP, results in an estimated EPS of 15.40% instead of 11.30%. That difference is no “small potatoes.”

(C) Another approach would be to check what sales growth the analysts were estimating. Cy says his 12.00% sales estimate is supported by Morningstar’s 13.00% estimate and Value Line’s 11.5% estimate.

** However, Cy did not check the only other analyst that makes a Sales estimate for the next 5 years, Zacks.com which was estimating 21.92% on 11-1-08. Three months later, on 3-18-09, its Sales estimate was down slightly to 22.19%.

** Morningstar’s Sales estimate for the next 5 years was way down from 13.00% to 8.00% on 3-18.

** Value Line does not make an explicit estimate of Sales growth and Cy implied VL’s 11.5% from its 8-22-08 dollar estimate which has dropped in VL’s next two quarterly reports to, using Cy’s method, 9.9% and 6.9%.

** So, should the Sales estimate for the next 5 years be 22% (from Zacks), 16% (ORCL’s 7 year history), 12% (by Cy), 11.5% or 9.9% or 6.9% (all implied from VL), or 8% (from Morningstar)? As you might guess, there is no “right” or “preferred” answer and your guess is as good as mine.

(3) The Second PP Element: 40.8% estimated PTPM for ORCL

The second element of the Preferred Procedure is estimating the Pre-Tax Profit Margin (PTPM) for the next 5 years. Cy estimated 40.8% PTPM which was ORCL’s average for the past 5 years based on VL data.

However, S&P data shows a much different PTPM: 36.6% average for the last 5 years and 35.2% for the last 3 years. Hemscott data from StockCentral.com shows 36.2% which is similar to S&P but again much different than VL.

Sooooooo, what is the best PTPM to use: a three year (35.2%) or five year average (36.6%) from S&P data, or 36.2% from Hemscott data, or 40.8% from VL data? Again, your guess is as good as mine as there is no “right” or “preferred” answer.

(4) The Third PP Element: 29.00% estimated Tax Rate for Oracle

Here, Cy estimated 29.00% as ORCL’s Tax Rate for the next 5 years which again was based on VL’s estimate. Cy says this seems reasonable, but does not explain that no other data source makes such an estimate and that we are pretty much stuck with relying on VL.

However, Value Line only makes estimates for 1500 stocks while over 7000 are included in the S&P data files and 7700 in the Hemscott data files. Still another problem with the PP is that, for the thousands of companies not covered by VL, there is no reality check to test the reasonableness of our estimates, no benchmarks to compare against.

(5) The Fourth PP Element: 5,230.8 estimated Shares Outstanding

For the fourth and last component of the Preferred Procedure, Cy makes a big deal of not relying on VL’s estimate of 4500 M shares and instead uses 5230.8 M estimated shares outstanding in the next 5 years. VL’s estimate is for basic shares while Cy’s estimate is for diluted shares which, he says, are what we should use for our SSGs.

Cy first converts VL’s basic shares to diluted and finds that to be unreasonable given ORCL’s share history and stated intent. He appears to suggest that VL doesn’t adequately know or appreciate those factors. Cy then decides to rely on 5230.8 M shares, some 18% more than VL, without telling us how he derived his final estimate.

Conclusions:

- By working through Oracle as an example, I’ve tried to demonstrate how the Preferred Procedure involves too many estimates and too much guesswork;

- The PP’s weakest link is its first component, an estimate of Sales growth for the next 5 years. Start low and you are almost certain to wind up low;

- Instead of making separate estimates of the PP’s four components to derive one EPS estimate, I prefer to more directly check long-term EPS estimates from six different data sources.

** I can determine what is out-of-whack and which are in the ball park.

** I don’t have to wonder about which of several possible Sales estimates to use, or weigh how best to estimate future PTPM and Taxes, or wrestle with converting basic shares to diluted shares, or worry about the differences between VL and S&P data.

- Even if you continue to use the Preferred Procedure, it’s still a good idea to make some comparisons to check the reasonableness of your estimates and, most importantly, your final result.

Armin

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Posted by arminfields

Filed in Estimating EPS, ORCL, Preferred Procedure, SSG ·Tags: Estimating EPS, ORCL, Ptrferred Procedure, SSG

2 Comments »

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DISCUSSION

August 18, 2009

July 15, 2009

Every SSG must make several judgments about the future, the most important of which is estimating the growth of earnings per share for the next 5 years. Estimating Sales growth is also important, especially when it is used to derive EPS growth as part of the BI/NAIC Preferred Procedure.

How do we determine what’s reasonable and what’s not? The answer is easy to express (by comparisons) but much more complex to explain. Consider this concrete example:

Is it reasonable to estimate 24.0% Sales growth for the next 5 years for Cognizant Technology Solutions (CTSH)? Is 21.4% EPS growth reasonable? How do we decide?

Moreover, over the last 5 years, CTSH’s annual growth rates actually increased to 55.3% Sales and 50.7% EPS. So what do you think is a reasonable estimate for CTSH’s future growth in the next 5 years?

Here is Cy’s answer: “…applying arbitrary limits to projected growth in your stock studies under the guise of being conservative can lead to missed opportunities. I find estimated revenue growth of 24 percent to be reasonable.” [emphasis added]

- For CTSH, Morningstar is estimating 32.10% Sales growth for the next 5 years and Zacks is estimating 55.66%. Cy’s 24.0% estimate is conservative by comparison even though it is greater than the 20.0% maximum advocated by some other BI gurus.

- When I looked again almost one year later on June 29, CTSH had fallen in price by -22% and the analysts had lowered their long-term EPS estimates to an average of 21.78% (down from 28.48%) with First Call low at 18.17% (down from 28.49%) and Value Line high at 28.50% (unchanged).

- Thus, 20.0% EPS is the very lowest estimate by any of these analysts and Cy’s 21.4% estimate seems conservative by comparison, especially compared to the 28-29.0% consensus analyst estimate.

- Thus, 20.0% EPS is the very lowest estimate by any of these analysts and Cy’s 21.4% estimate seems conservative by comparison, especially compared to the 28-29.0% consensus analyst estimate.

- Certain tax breaks that CTSH receives from the Indian government are ending and Cy’s 25% Tax Rate estimate is close to Value Line’s 24% estimate in the next 3-5 years and identical to Morningstar’s estimated long-term tax rate of 25%.

- Cy wrote that his 300M Shares Outstanding was based on VL’s estimate, but VL was actually estimating 288M Shares Outstanding as per its 5-23-08 report. If Cy had used that number, his EPS estimate would have increased from 21.4 to 22.4%.

(B) Determining if our SSG Forecast High PEs and High Prices are Reasonable:

- Cy’s SSG estimated 21.4% EPS growth for CTSH and a 29.0 Forecast High PE that resulted in a $94.50 Forecast High Price, only $4.50 per share or 5.00% more than VL which, by comparison, seems reasonable to me.

- Keep in mind that VL provides benchmark guidance and is not an iron law. What’s most important, I think, is not to overlook or ignore Value Line’s guidance.

March 28, 2009

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