Brainstorming BRLI (Bio-Reference Labs)

 – Bio-Reference Laboratories (BRLI) is the third largest full service laboratory in the U.S., according to the company’s website, and the largest independent regional laboratory in the Northeast.  It is primarily a clinical testing lab that serves physician offices, mostly in the greater New York City metropolitan area.  

– Based on BI/NAIC criteria, BRLI is a small sized company with annual sales under $500 M (it had $301 M in 2008).  SSGers often have difficulty finding small companies to buy and, in 2009, I analyzed two others; click the following links if you’re interested:

** Studying Strayer (STRA), Nov 29, 2009 ($245.5 M sales in 2008)

** Quantifying Quality Systems (QSII), Feb 15, 2009 ($396.3 M sales in 2008)

Company Background:

– BRLI operates two clinical laboratories, two pathology labs, and three other specialty labs.  In addition to routine testing, BRLI also specializes in esoteric testing which includes molecular diagnostics, anatomical pathology and correctional health care.

 ** Routine lab tests generate about 50% of its net revenue as do esoteric tests which cost more.

 – BRLI also operates as a national oncology laboratory under its GenPath brand and a national lab for sexually transmitted diseases and Women’s Health.  Moreover, GeneDx, a wholly owned subsidiary, is the BRLI genetics laboratory.

– Through its PSIMedica unit, BRLI also operates a clinical knowledge management service.  This system uses data from lab results, prescription drugs, and claims to provide administrative and clinical support.

– And, through its CareEvolve subsidiary, BRLI also operates a web-based portal to provide ordering and lab results to its physician customers.

– BRLI has averaged 20% or more Sales growth over the last 5, 3 and 1 years with S&P data.  EPS growth has averaged 19% over the last 5 years, increasing to 27.5% 3 years ago, and down to 22% last year.

– Its Q3 sales of 25% Sales was the best ever in the company’s history; EPS was up 35%.

Financial Condition:

– There is no Morningstar financial appraisal because there is no Morningstar report and there is no Value Line assessment because BRLI is only covered in VL’s small and mid-cap edition which does not evaluate the company’s financial condition.

– The Bob Adams one-click annual report spreadsheet is especially useful here because all public companies can be evaluated.  It gives BRLI’s latest A.R. a 63 out of 100 with nine bullish and seven bearish results:

** The bullish, good things include: sales are increasing and increasing faster than their related costs; gross profit margin is increasing; debt is decreasing; and gross profit margin is increasing and is greater than the industry average;

** The bearish, not-so-goods include: accounts receivable are increasing; free cash flow should be higher and is less than sales growth;

** You can get a link to this free, super-duper spreadsheet and an explanation of its several features by going to my Favorite Links page: click here.

SSG Discussion:

– The table below compares two SSGs from the BI First Cut page with one of mine and with Take Stock.  After the table, I discuss several ssues identified by the comparison.

Bio-Reference Labs (BRLI)	JulieM	BobM	Armin	Take Stock
Date	9-30-09	11-15-09	12-2-09	Same
Data	S&P	Same	Same	Hemscott Morningstar
Price	$39.26	$32.52	$33.51	Same
52 week High  & Low Price	$36.13 &         $18.35	$36.25 &        $20.00	Same &                $20.08	N/A
Last Q of Reported Data	Q3 ending       7-31-09	Same	Same	Same
Software Used	TK 6	Same	TK 5	Online TS
Project Growth     From End of	Last Q	Same	Same	Last FY
Sales Growth	15.00%	17.00%	12.00%	20.00%
EPS Growth	15.00%	16.10%	14.00%	10.40%
High PE	30.0	29.0                  (from 2008, rounded)	29.1                    (from 2008)	28.2
High EPS	$2.74	$2.87	$2.40	$1.83
High Price	$82.20	$83.20	$69.80	$51.61
Value Line Small Cap Edition Estimated High Price = NOT AVAIABLE
Low PE	15.0	15.2	16.2                        (from 2008)	11.3
Low EPS	$1.23                (Last FY)	$1.36             (TTM)	Same               Same	$1.20
Low Price	$18.50	$20.70	$22.00	$13.56
Upside/Down	3.0	4.3	3.2	0.91 (imputed)
Total Return	19.10%	20.70%	15.80%	09.00%
SSG Buy Under	N/A	N/A	$33.95	$23.06
RV/PRV         (no outliers)	99.6/86.6	94.5/81.4	97.2/87.0	N/A
Quality	S&P = N/A	S&P = N/A	S&P = B	3.2 (un-acceptable)
PTPM –         5 yr ave	08.60%       Trend even	09.00%            (05 out)          Trend even	08.60%              Trend even	08.50%   Trend N/A
ROE -5 yr ave               End Equity	17.20%    Trend down	19.90%            (04 out)    Trend even	17.20%              Trend down	N/A
ROE –5  yr ave          Start Equity	N/A	N/A	21.20%                Trend down	20.6%              Trend N/A
Debt to Equity –  5 yr ave	09.60%           Trend down	Same             Same	09.30%             Same	N/A

Estimating Future EPS Growth:

– Julie wanted to be conservative and chose the same 15% EPS growth rate as her Sales estimate.

– Bob used the NAIC/BI Preferred Procedure and got 18.1% EPS but, because that was higher than an analyst estimate of 16.3%, he also wanted to be conservative and used 16.1%.

– When I did my SSG, the seven analysts I always check were closely estimating long-term EPS at an average of 18.60% with FactSet CallStreet via CNNMoney.com high at 20.00% and Zacks.com low at 17.67%.  VL was 17.7%, Reuters was 18.25%, Thompson Reuters via YahooFinance was 18.75%, and FactSet via Morningstar.com was 19.30%

** The 3 analysts at FactSet CallStreet via CNNMoney ranged from a low of 16.0% to a high 0f 20.0% while the 4 at FactSet via Morningstar ranged from a low of 15.0% to a high of 20.0%.

** The average less 1 Standard Deviation was 17.7% and the average less 2 SDs was 16.9%

** Usually, I don’t go lower than the average less 2 SDs, but wanted to show that I could still satisfy the SSG Buy criteria with an even lower estimate.  So, I chose 12.00% EPS growth.  For how I estimate EPS for all my SSGs, see Estimating EPS 

– Take Stock used 10.4% primarily because it determined that historical growth was only 11.1%.  TS did not explain how it derived 10.4%.

** When I looked at Hemscott data, I saw that 11.1% was the EPS growth for the last two years, but that 14.9% was the rate for the last 3 and 17.1% for the last 5 years.

 Relative Value/Projected Relative Value:

– Bob uses an RV standard of 85-100 for every SSG he completes.  Bob, Julie and I all satisfied that criteria while Take Stock does not use the RV or PRV concepts.

– I am not a fan of the RV (the current PE divided by the five-year average PE) for several reasons:

** First, RV changes due to the PE outliers we eliminate.  Often, SSGers don’t agree on outliers and/or don’t tell one another what they’ve eliminated when they discuss SSGs.  Here, none of us removed any outliers so our RVs were comparable;

** Second, RV looks better as the price and then the PE drop.  During our current recession, as the Ps and Es have both dropped, I think RV sends a misleading signal. See: BI/NAIC Stock Selection Handbook written by Bonnie Biafore, page 63;

** Bonnie’s understanding of RV is considerably different than Bob’s: she applies a different standard (110 is her upper limit, not 100) and she uses the average PE after outliers have been removed (which Bob does not do).  BI/NAIC Handbook, page 113.

Pre-Tax Profit Margin (PTPM), Return On Equity (ROE):

– For how I investigate PTPM, ROE and competitors, see Investigating Industry Info

PTPM:

– With S&P data, BRLI’s Pre-Tax Profit Margin is the same as its industry average (Health Care Services industry, 8.60%).

** Julie thought BRLI’s average was low, but hadn’t checked industry averages or competitors;

** Bob eliminated 2005, presumably because it was a low outlier, so his PTPM average was different and not factually comparable;

– With Hemscott data, BRLI’s PTPM (8.50%) was substantially below its industry average (15.3%, Medical Labs and Research industry).  None of the 30 companies distorted the average and BRLI ranked 9^th.

 ROE:

– With S&P data, BRLI’s Return on Equity (17.2%) was slightly better than its industry (15.4%).

** Julie didn’t address the downtrend in ROE

** Bob eliminated 2004, presumably because it has a high outlier, but that changed the trend to even from down which he missed or ignored.

 – With Hemscott data, BRLI’s ROE (16.7%) was slightly below its adjusted industry average (18.6%) after I removed AIQ’s ROE (266%) which distorted the average.

 

Armin

 

Studying Strayer (STRA)

[AF addendum: Strayer Education , discussed below, is also the subject of a short article by Cy Lynch, BI’s growth stock guru, and his completed SSG both appear in the January 2010 on-line issue of Better Investing Magazine.]

– One purpose of this post is to demonstrate the powerful effect of projecting future growth from the last quarter of reported data vs. the last fiscal year.

** With that single change, my Forecast High EPS was some 16% greater than the Ken Kavula/Consensus SSG Forecast High EPS for Strayer Education (STRA).  Strayer was the Online Stock Study for October, we both used the same EPS estimate, and the only difference was that I projected growth from the end of the last Q while Ken & the Consensus projected from the end of the last FY. 

– Another purpose is to evaluate the different judgments that led Ken & the Consensus to decide that STRA was a SSG Buy while I concluded that it was a SSG Don’t Buy.

Online Stock Study:

– Strayer Education (STRA) was the Online Stock Study for October 2009 at the Better Investing website and was led by Ken Kavula, chairman of the BI Advisory Board and a small company guru. 

– BI members can download the Audio Presentation (54 mins), Presentation Slides, Value Line Reports, and the Completed SSG.

Company Background:

– Strayer Education (STRA) and its subsidiary, Strayer University, are for-profit companies.  At the end of 2008, SU had some 46,000 students at 71 campuses in 15 states (mostly on the SE coast) and a large online student body.

– SU offered the following degrees: Bachelor’s (54%), Master’s (27%) and Associates (11%) and its students were majoring in Business/Economics (61%), Information Systems (16%), and Accounting (12%). 

 – Morningstar reported that enrollment growth has averaged 18% per year for the last 5 years due to additional online students and new campuses.  Strayer currently seeks to add about 6-11 campuses annually.

– Morningstar also reported that Strayer has a lower cost structure than traditional schools, but offers its courses at similar prices.  And, according to Reuters, online courses are priced the same as on-campus offerings with over 32,000 students participating in SU’s online programs.

– Strayer’s revenue comes from three sources according to Wikinvest: about half is paid via federally insured loans, about 20% is paid by companies whose employees attend SU, and the rest is paid directly by students.

– Graduate level tuition at SU costs $2050 per course and undergraduate tuition costs $1515 per course for full-time students and $1590 for part-timers.  A BBA degree requires 180 credit hours and costs (at 3 credits per course) some $95,000.

– In Q 3, which ended 9/30/09, revenues increased 31% due to increased enrollment and a 5% tuition increase that was effective January 1^st. Enrollment increased 22% to 54,317 students with 39,129 taking at least one online class.

Company Financials:

– Value Line gave Strayer an “A” for Financial Strength, reported no debt and $38.6 M in cash as of 6/30/09.

– Morningstar says that Strayer is in “excellent” financial health with no debt and has the highest score for financial responsibility from the US Dept of Education.

  Discussion:

– The following table compares the Consensus & Ken Kavula SSG with two of mine and with Take Stock.  The only difference between my two SSGs is that Armin-1 uses S&P data while Armin-2 uses Hemscott-Morningstar data.  After the table, I discuss issues identified by the comparison.

Strayer Education  (STRA)	Consensus & KenK’s SSG	Armin’s                  SSG-1	Armin’s                SSG-2	Take Stock
Date	10/6/2009	Same	Same	10/3/09
Data	S&P	S&P	Hemscott-Morningstar	Hemscott-Morningstar
Price	$221.10	Same	Same	$211.83
52 week High &        Low Price	$239.99 &      $143.53	Same	Same	Not Included
Last Q of Reported Data	Q2 ending 06/30/09	Same	Same	Q2 ending 06/30/09
Software Used	Online SSG	TK 5	Same	TS Online
Project Growth         From End of	Last FY	Last Q	Last Q	Last FY
Sales Growth	19.00% (Consen.) 18.00% (Ken)	Same	Same	20.00%
EPS Growth	19.00%	Same	Same	18.50%
High PE	35.0 (Ken)	30.0	Same	30.0
High EPS	$13.53	$15.77	$15.74	$13.24
High Price	$473.55                    (4.0% > VL)	$473.10                    ($4.0% > VL)	$499.80                    (9.8% > VL)	$397.20
Value Line Estimated High Price = $335-455 as of 7/31/09
Low PE	25.0 (Ken)	18.7	Same	16.5
Low EPS	$6.61	Same	$6.60	$6.28
Low Price	$165.77	$123.60	$123.40	$156.60 (yield supported low)
Upside/Down	4.52	2.60	2.90	3.36 (imputed)
Total Return	17.91%	17.00%	18.8%	15.10%
SSG Buy Under	Not Included	$210.98	$217.50	$213.97
RV/PRV                        (no outliers)	Not Included	101.5/85.4	95.2/89.5	Not Included
RV/PRV                        (2004 out)	Not Included	106.4/89.5              (2004 out)	101.0/89.6             (2004 out)	Not Included
Quality	Ken = Pass	S&P = A	None	TS = 10 (highest)
PTPM –  5 yr ave	33.94%                  Trend N/A	33.9%                    Trend Down	Same                    Same	33.90%            Trend N/A
ROE – 5 yr ave          End Equity	33.47%                    Trend N/A	33.5%                       Trend Up	Same                     Same	Not Included
ROE – 5 yr ave          Start Equity	N/A	36.7%                        Trend Up	49.1                Trend Down	47.1%                 Trend N/A
Debt to Equity –         5 yr ave	-0-                              Trend Even	Same	Same                       Same	Not Included

(1) CONSENSUS & KEN’S SSG:

Future Sales Growth:

– Ken gave the group 5 choices to estimate STRA’s future Sales growth: 22.00%, its ten year historical growth; 21.00%, its five year historical growth; 22.80%, Value Line’s estimate [??]; 19.00%, Morningstar’s estimate; and Other.

** Value Line makes no long-term Sales estimate and Ken did not explain how he determined that 22.80% was VL’s estimate.

– The Consensus (49%) agreed on 19.00%, Morningstar’s estimate, but Ken decided that 18.00% was better even though it was not offered as a choice.

– Ken has a strange understanding of consensus decision-making!!

Future EPS Growth:

– Ken used the NAIC/BI Preferred Procedure as one estimate of future EPS growth and relied essentially on the software default values: Sales = 18.0%; Pre-Tax Profit Margin = 34.0% (the only change from the 33.9% default); Taxes = 38.5%; and Shares Outstanding = 14.0 M.  His PP result was 19.0% EPS.

** One participant asked why he didn’t use VL’s higher estimate of 14.5 M shares outstanding in the next 3-5 years and Ken said he thought VL’s report on Strayer was too aggressive.

– Ken gave the group 5 choices to estimate future EPS growth: 20.00%, the S&P estimate; 18.60%, STRA’s 10 year historical growth; 24.60%, VL’s estimate; 19.00%, Ken’s PP; and Other.

– The Consensus (47%) agreed on 19.00%, Ken’s PP, and not surprisingly Ken did not disagree this time.

Forecast High PE:

– Ken offered 5 choices: 40.4, the 5 year average High PE; 38.2, the 10 year average; 42.6, the 2 year average; 42.3, the most recent year High PE; and Other.

– Before the vote, Ken said he personally would only use the “Other” choice, but gave no further guidance.  It’s no surprise that the Consensus (76%) chose “Other” and Ken then chose 35.0, but gave no reason.

Forecast Low PE:

– Ken gave participants 5 choices: 25.3, the 5 year average Low PE; 21.1, the 10 year average; 24.2, the 2 year average; 25.1, the most recent year Low PE.

– The Consensus (39%) chose 21.1, the 10 year average, but Ken again disregarded the Consensus and selected 25.0, and again gave no reason.

Final Results:

– Neither the Forecast High nor Low Prices involve judgment with the Onlune SSG:

** The Forecast High Price is simply the product of the Forecast High PE (30.0) multiplied by the Forecast High EPS ($13.53) which totaled $473.10, some 4.00% greater than the high end of VL’s $335-455 High Price estimate.  I guess this VL estimate was not too aggressive for Ken.

** The Online SSG offers no options to decide the Forecast Low Price, unlike our SSG software, and relies soley on the Low PE x Low EPS which totaled $165.77.

 (2) Armin’s SSG:

Projecting Growth From:

– SSG software lets us choose from three options to project future growth (Last FY, Last Q, the historical trend line) and I chose the Last Q in order to demonstrate the powerful effect of this decision.

– Ken chose to use the Online SSG which offers no options and always projects growth from the Last FY.

 Future EPS Growth:

– I deliberately used 19.00% EPS growth, just as Ken did, and got a High EPS of $15.77 compared to his $13.53, a difference of 16.6% with S&P or with Hemscott-Morningstar data which, to me, is no small potatoes.

** The difference would have been 23.3% if I had projected from STRA’s Q3 which ended on 9/30/09, but was reported after the Online Stock Study, and Ken & the Consensus continued to use the Online SSG and project growth from the last FY.

– The seven different analysts I always check for every SSG were estimating long-term EPS at 21.06% with Value Line high at 25.00% and FactSet via Morningstar.com low at 19.50%.  S&P and FactSet CallStreet via CNNMoney.com were both 20.00%, Zacks.com was 20.44%, Reuters was 21.24%, and Reuters Thomson via Yahoo Finance was 21.25%.

– The six analysts at FactSet Call Street via CNN Money.com ranged from a low of 14.00% to a high of 23.0%.  The six analysts at Reuters.com ranged from a low of 18.00% to a high of 24.40%. 

 – Any EPS estimate lower than 14.00% is way too low for me while higher than 24.40 or 25.00% seems way too high.  These low and high estimates are how I determine what’s reasonable and what’s not; see: Determining What’s Reasonable and What’s Not: An Update 

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

Forecast High PE:

– I used 30.0 compared to Ken’s 35.0 which I thought was too high.  Toolkit’s Alt-M command usually is the most conservative option.  It eliminates the 5 highest High PEs in the last 10 years, averages the rest, and shows 31.9 with S&P data (31.5 with Hemscott data).  The Online SSG that Ken used does not include the Alt-M command.

Forecast Low PE:

– The major difference between Ken’s SSG and mine is our Forecast Low PEs.  Ken used 25.0 while I used 18.7.  This explains why I got a SSG Don’t Buy while Ken got a SSG Buy.

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

– Ken missed or ignored the 5 year downtrend in PTPM (Presentation Slide 26) which typically signals a red-flag warning sign of potential trouble.

– STRA’s PTPM us better than its Industry Average (33.9% vs 14.4%), but the company’s ROE is worse than its Industry Average (33.5% vs 39.9%).

– Ken compared STRA to three peers: Apollo Group (APOL), ITT Educational (ESI) and DeVry (DV).  He found that STRA was better than the three peers in terms of PTPM, but worse than 2 of the three in terms of ROE.

 – Armin

Contemplating Cognizant (CTSH)

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 ave                  End Equity	Not Included	21.5%               trend even	21.0%                trend even	Not Included
ROE – 5 yr ave                  Start 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

Checking Out Coach (COH)

[AF addendum: PV’s SSG and First Cut write-up, discussed below, are also summarized in the January 2010 issue of Better Investing magazine.]

– 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

Researching RMD (ResMed)

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

Measuring Medtronic (MDT)

[AF addendum:  Jay P’s SSG and First Cut write-up of Medtronic, 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.]

Monitoring Microsoft (MSFT)

[AF Addendum: The Online Stock Study of Microsoft, discussed below, is also summarized in the January 2010 issue of Better Investing magazine.]

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%

This slideshow could not be started. Try refreshing the page or viewing it in another browser.

.

– 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) .

– 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 .

–  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

Flirting With Fresenius (FMS)

Fresenius Medical Care (FMS) is the world’s largest provider of dialysis services and products to patients with chronic renal disease.  It has some 2400 dialysis clinics in 30 countries, 70% of which are in the North America. In the United States, it also performs clinical laboratory testing and inpatient dialysis services and other services under contract to hospitals. 

FMS is a German company, sold as an ADR in the U.S., whose full name is Fresenius Medical Care AG & Co. KGaA.

COMPANY BACKGROUND:

According to the Reuters company report, Fresenius provided dialysis treatment to 184,000 patients in 2008, 84% were in the U.S.  During the year, FMS acquired 48 clinics, opened 127 new ones, and sold or consolidated 25.  It also launched UltraCare at Home which offers the full range of treatments and service to patients who want in-home care.

Fresenius’s most recent quarterly report shows that 62% of its revenues for the second quarter of 2009 came from North America, 22% from Europe, 6% from Asia-Pacific, and 4% from Latin America.  FMS gets about 36% of its total revenue from Medicare and Medicaid, and any reduction in reimbursement could be very detrimental.

The company’s corporate goal, adopted in 2005, is 7-9% annual revenue growth until 2010 as well as a 10% increase in net income.  This is from its Fact Sheet available at the FMS website.  Morningstar estimates a compound annual revenue growth of 7% through 2013.

Morningstar thinks FMS has several advantages over its competitors. In addition to providing dialysis services, it also sells dialysis products many of which are bought by its competitors. And, with its recent purchase of U.S. based Renal Care Group, FMS owns one of every three dialysis clinics in the U.S.  That’s key when location is important to both patients and physicians.

The one-click Annual Report spreadsheet by Bob Adams shows that FMS’s 2008 report rates a 49 out of 100 with six Bullish results (including decreasing accounts receivable, debt and shares outstanding) and twelve Bearish results (including inventories and cost of sales increasing, and inadequate ROE).  You can get this super-duper spreadsheet and a summary of its many features by going to my Favorite Link page, click here.  

DISCUSSION:

The table below compares the SSG by SaulS, which I got from BI’s First Cut page, with two SSGs of mine and with Take Stock.  The only difference between my two SSGs is that Armin-1 uses Hemscott-Morningstar data (like Saul did) while Armin-2 uses S&P data.  After the table, I discuss several SSG issues that were identified by the comparison.

Fresenius Medical Care (FMS)(ADR)	SaulS	Armin-1	Armin-2	Take Stock
Date	7-10-09	7-14-09	Same	Same
Data	Hemscott – Morningstar	Same	S&P	Hemscott -Morningstar
Price	$44.46	$43.89	Same	Same
52 week High &          Low Price	$58.38 & $34.30	Same &         Same	Same &       Same	Not                 Included
Last Q of                       Reported Data	Q4 ending 12/30/08	Same	Q1 ending 3/31/09	Q4 ending 12/30/08
Software Used	TK 6	TK 5	Same	TS Online
Project Growth          From End of	Last                  Quarter	Same	Same	Last                  Fiscal Year
Sales Growth	11.00%`	10.00%	Same	09.00%
EPS Growth	12.50%	09.50%	Same	07.64%
High PE	20.0	19.2               (Alt-M)	21.0         (Alt-M)	19.2
High EPS	$5.02	$4.39	$4.33	$4.03
High Price	$100.40	$84.30	$90,90	$77.49
Value Line Estimated High Price = NOT AVAILABLE
Low PE	14.0	12.0               (Alt-M)	12.5         (Alt-M)	12.0
Low EPS	$2.79	Same	$2.75	$2.79
Low Price	$39.00	$33.50	$34.40	$33.48
Upside/Down	10.2	3.9	5.0	3.2                (imputed)
Total Return	19.0%	15.3%	17.0%	13.5%
SSG Buy Under	N/A	$44.51	$47.98	$41.38
RV/PRV                           (no outliers)	77.7/68.8	82.2/75.2	83.2/75.9	Not                  Included
Quality	4.7 (from Take Stock)	Not                   Included	N/A	4.7
PTPM – 5 yr ave	11.4%               Trend up	Same	11.8%  Trend up	11.4%            Trend N/A
ROE – 5 yr ave          End Equity	N/A	10.8%          Trend up	10.9%  Trend up	Not               Included
ROE – 5 yr av      Start Equity	11.5%              Trend up	Same	11.6%  Trend up	11.5%              Trend N/A
Debt to Equity –          5 yr ave	???	???	73.0%  Trend up	Not              Included

 (1) Estimating EPS:

– When I did my SSGs, the 5 analysts I checked were estimating long-term EPS at an average of 12.20% with S&P high at 15.00% and both FirstCall via YahooFinance and Reuters.com were low at 10.83%.  Zacks was 11.33%, FactSet CallStreet via CNNMoney was 13.00%, and Value Line made no estimates as its report was in its Small and Mid-Cao Edition.

** FactSet’s estimate came from 6 analysts who ranged from 17.0% high to 10.0% low.  Reuters 4 analysts ranged from 14.0% high to 9.32%.

** I estimated 9.50% EPS, some 3.00% less than Saul, 2.70% less than the consensus average, and almost the very lowest of any analyst (9.32% at Reuters).

– A new feature of TK 6 allows the Preferred Procedure to show on the front page of the SSG which shows that Saul did not use the PP.  Saul’s used 12.50% EPS which he said was conservative because it was almost 3.0% less than FMS’s historical average. 

** However, 12.50% EPS was not conservative compared to the consensus average of the five analysts I checked (12.20%).  Nor was it conservative compared to Saul’s default PP of 9.60%.

(2) Forecast High & Low PEs:

 – I knew nothing about FMS before I did my SSG.  In such a case, and without any Value Line for guidance, I usually choose my initial Forecast High PE by using Alt-M.  That is often Toolkit’s most conservative option which averages the lowest 5 High PEs in the last 10 years. See: Determining What’s Reasonable and What’s Not: An Update

– Saul Forecast High & Low PEs were 20.0 & 14.0 which were close to my Alt-M’s 19.2 & 12.5.  Saul’s Low PE was from 2008.

(3) Debt to Equity:

– Using the same Hemscott data, Saul and I differed on Debt/Equity which should not happen.  Because Saul’s SSG was in PDF format I could not examine his annual data. 

– However, I spoke to Technical Support at IClub Central, the maker of our Toolkit software, and confirmed that my TK 5 was not broken.

 4) Final Results:

– With Hemscott data, Saul and I got SSG Buys (with U/Ds > 3.0 and TRs > 15%), but Take Stock did not as its TR was only 13.5%.

– Armin-1 is a SSG Buy that is well under Saul’s, but it is still a SSG Buy.  Saul got a 10.2 U/D and 19.0% TR whereas I got 3.9 U/D and 15.3%.

– Double-digit U/Ds are a red-flag warning sign for me to rethink my judgments as they might be too high.

– With S&P data, but with the same judgments, Armin-2 is a much better SSG Buy than Armin-1 with Hemscott data. That’s because Armin-2 has one later quarter of data than Armin-1.

(5) Final Thoughts:

– FMS is not recession-proof, as I would have thought, and Sales growth has declined in the last two years from 16.0% to 11.7% in 2007 to 9.2% in 2008 (Hemscott and S&P data are identical). 

– I don’t know anything about dialysis so maybe you could help me by answering some questions:

 ** Can dialysis be delayed or deferred; for exampke, can a twice-a-month schedule safely be changed to once-a-month?

 ** How much does each dialysis visit cost a Medicare patient (in dollars), a non-Medicare patient with “good” insurance coverage, a non-Medicare patient with no insurance?

Armin

[AF: please rate this post by using the new, mouse-over star system at the top and/or leave a comment below.  Let me know what you think.]

Pouring Over Pepsi (PEP)

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, https://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, https://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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Projecting Growth at Patterson (PDCO)

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, https://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, https://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, https://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?

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Armin