All About SSGs

In my first post on this Blog, I briefly explained the Stock Selection Guide (SSG). Now, some one and a half years and 22 posts later, I think it is time to elaborate.

The SSG is a two-page form that arrays 10 years of historical data and, based on the SSGer’s judgment, projects five years into the future to determine two fundamental issues: (A) is this a “good” quality stock and (B) is it selling at a reasonable price. The SSG was developed by the NAIC, now named Better Investing, which emphasizes fundamental investing for the long-term.

Four factors determine the assessment of quality: Sales Growth, EPS Growth, Pre-Tax Profit Margin, and Return on Equity. Two factors primarily define a reasonable price: the Reward/Risk or Upside/Downside Ratio which has to be a 3.0 or better and the Projected Compound Total Return which has to be a minimum of 15% per year for the next 5 years. The stock is a SSG Buy if it satisfies both criteria which BI/NAIC has defined.

Drew Foley recently left a comment about my post on GameStop Corp (GME) and I decided to answer him here because it explains my approach to SSGs and mentions several SSG resources that others might find useful.

” I read your post on GME with intrest. I’m trying to learn the ssg system and your comments at the end of your analsys left me with a question. If all of he places you checked to get the info are different and undependable, where could you get more accurate data?, perhaps GME’s investor relations. “

First, the SSG depends on an EPS estimate for the next 5 years and company investor relations departments rarely, if ever, provide estimates of the future. They all provide historical data as required by the SEC and so do many websites. My favorites are Reuters and MSN Money which are both comprehensive sites and mostly free.

Second, I was only complaining about First Call/Thomson which had three different estimates for the same company at three different websites. I also check Zacks EPS estimates via Clear Station.com, Reuters estimates from Reuters.com, FactSet CallStreet estimates from CNNMoney.com, Value Line estimates (from my public library), and S&P EPS estimates, the only one I pay for, via a data subscription from Better Investing (old NAIC).

I usually wind up using the Reuters estimate less 1 Standard Deviation which the website provides, but I ALWAYS check them all to know for sure what’s in the ballpark and what’s not. If you don’t check, you NEVER know!

I no longer use the so-called Preferred Procedure, BI/NAIC’s preferred method for estimating EPS growth, and I explained my reasons in an earlier post: Considering Kohl’s (KSS) and Reconsidering NAIC’s Preferred Procedure, September, 13, 2006. In short, the Preferred Procedure involves too many estimates and too much guesswork for me. Beginners should try the Preferred Procedure and compare it to my approach to decide for themselves what works best for them.

Anyone can get a 30-day free trial of a BI/NAIC membership together with a data subscription (from http://www.better-investing.org), and a free demo of the Toolkit 5 software (from http://www.iclub.com/products/tk5.asp) that I use to do my SSG analysis. You can also do the SSG by hand or enter the data manually, but that involves tedious calculations and data entry. What’s nice about the BI/NAIC data subscription is that you can import all the data you need into the SSG software in seconds. The data is from S&P Compustat, covers 7000 stocks, and includes an EPS estimate for the next 5 years.

Third, there are several reasources that can help people learn about SSGs. Among them are:

[1] Better Investing.org has a new feature for members called the monthly Online Stock Study which takes you through completing a SSG for specific companies (three so far: on SPLS, PG and COH);

[2] BI membership provides a monthly magazine which features 4 stocks every month, and I try my best to SSG all of them;

[3] BI sells a Stock Selection Handbook ($15) that is thorough and readable, and local Chapters teach SSG classes all the time for a modest fee;

[4] BI also runs the separate I-Club-List (free to the public) where you can ask and answer investing questions, especially SSG questions;

[5] StockCentral.com has ticker-based discussion forums and extensive resources, geared to long-term BI/NAIC-type investing, and you can get a 45 day free trial.

Fourth, data…even historical data…differs at different websites as they all make different adjustments to present what they think is the “best” picture of company operations. Data differences are just a (messy) fact of investing life.

Fifth and last, the heart and soul of the SSG is judgment, hopefully good judgment. Many BI/NAIC gurus advocate a bunch of rules about judgment, such as NEVER estimate EPS more than 20% for the next 5 years, NEVER project a High PE greater than 30, NEVER project a low PE greater than 20, NEVER wind up with a PEG ratio greater than 1.5 (or 1.7, or 2.0). I reject those rules as arbitrary and unreasonable, because one rule or one number does not fit all stocks.

– I have two general rules to test the reasonableness of my SSG judgments: (1) I try to make a reasonably conservative EPS estimate for the next 5 years which, for me, is most often the Reuters estimate less one Standard Deviation; and (2) I don’t want my SSG’s Forecast High Price to substantially exceed Value Line’s Estimated High Price.

– I’m willing to break these two rules on occasion, but only after I more fully research the company. Before I buy any stock, I read: the company’s latest 10K and 10Q reports, any Value Line and Morningstar report (which I get free from my library), and lots of news about the company, especially from Google Finance and the Motley Fool.

– The essence of my two general rules is that they involve a comparison to some investing authority. With judgment, there is no right or wrong, but there is good judgment and bad. For me, I define good judgment in terms of a comparison to some outside standard….and NEVER in terms of what my “gut” or what my “experience” tells me is reasonable or unreasonable. I ALWAYS want “good” reasons.

Armin