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

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

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

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

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

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

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

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

DISCUSSION

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CONCLUSIONS:

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

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

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

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

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

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

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

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

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

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

– Armin

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

 

Considering Costco (COST)

[AF: On 7-8-09, I  added some new material at the end of this post]

Costco is my favorite retailer: I find lots of bargains, lots of fashionable clothing, and lots of tasty food, all at low, low prices.  We only buy what we use so the large quantities that are part of the deal are no hardship.

Costco also has lots of free tastes to sample everyday, a kosher frank and soda for $1.50 (unchanged for 20 or so years), and an annual membership fee that pays for itself in savings with one or two big purchases.

Best of all, COST has a hassle-free return policy and adds one year to the standard one-year warranty for electronic products.  Even better, when I used the Costco American Express card to buy my laptop, I got a third year of warranty protection for free.

COMPANY BACKGROUND

– Costco Wholesale (COST) operates some 560 membership warehouse clubs, 403 in the U.S. and the rest in six other countries according to Value Line.   About 52% of its sales were from food and sundries.

– According to Wikipedia, Costco’s sales were $71B in 2008, up 12.5% due to an increase in same store sales and the opening of 24 new clubs.  COST is slowing its domestic expansion and focusing on international markets for future growth.  It plans to open 14 new international stores in 2009-2010.

–  Morningstar reported that COST has 55 million members, with 30% of its clubs in California, and seeks to add 6-9 clubs per year.  Its immediate strategy is to grow its ancillary businesses (such as gas stations, pharmacies, and optical services) to boost sales and to generate more frequent shopping visits.

** Despite tough economic times and recent disappointing performance, Morningstar also explained that Costco is strictly adhering to its policy of not marking up any item by more than 15%.  Charging low prices for quality merchandise and paying generous wages and benefits leads to slender profit margins: a 2.9% average Pre-Tax Profit Margin for the last 5 years and 2.8% in 2008.

** Morningstar predicted that Costco would expand to 750 warehouses by 2018 and estimated 5.0% annual sales growth for the next 10 years.

– I used Bob Adams’ one-click spreadsheet to analyze COST’s 2008 Annual Report which found: 9 Bullish results (good things), 8 Bearish results (not-so-goods), 3 red flags (Free Cash Flow and its Return are both low, Quick Ratio is also low), and 17 green flags (very good things) for an overall score of 61 out of 100.

** You can get a link to Bob’s free spreadsheet and a summary of its many features by going to my Favorite Links page: click here.

COST COMPARISONS <grin>:

 The table below compares the SSG by CalvinG, which I downloaded from Better Investing’s First Cut page, with two of mine and with Take Stock.

My two SSGs use the same judgments with one exception: Armin-2 projects growth from the last Fiscal Year while Armin-1 projects growth from the last Quarter of reported data.  Armin-2 is a SSG BUY, but Armin-1 is not. <grimace> 

Costco Wholesale (COST)	CalvinG	Armin-1	Armin-2	Take                 Stock
Date	6-12-09	6-18-09	Same	Same
Data	BI S&P             Online	BI S&P	Same	Morningstar-Hemscott
Price	$47.00	$46.24	Same	$46.24
52 week High &      Low Price	$74.89  &     $38.17	Same &         Same	Same &        Same	n/a
Last Q of Reported   Data	Q3 ending       5-09	Same	Same	Q2 ending             2-09
Software Used	BI Online SSG	TK 5	Same	Take Stock Online
Project Growth         From End of	Last FY            (No Options)	Last             Quarter	Last FY	Last FY                (No Options)
Sales Growth	8.00%	9.00%	Same	9.80%
EPS Growth	8.00%	9.00%	Same	9.10%
High PE	18.0	20.0	Same	24.4
High EPS	$4.28	$4.00	$4.48	$4.97
High Price	$77.04	$80.00	$89.60         12% > VL	$109.24               36% > VL
Value Line Estimated High Price = $65-80 at $47.07 as of 5-8-09
Low PE	15.0	14.6	Same	17.9
Low EPS	$2.91             (Last FY)	$2.7            (TTM)	$2.91	$2.72
Low Price	$43.65           (Low PE x         Low EPS,          No Options)	$30.20 (Recent        Severe Low)	Same	$48.69              (Higher than Current Price)
Upside/Down	8.88	4.2	5.5	Impossible to Calculate
Total Return	11.43%	12.1%	15.2%	20.1%
Final Recomm-endation	BUY	HOLD	BUY	n/a
SSG Buy Under	Not Included	$40.72	$46.43	$57.82
RV/PRV	Not Included	83.2/76.2	82.9/76.0	Not Included
Quality	n/a	A-	Same	3.20                   (Unacceptable)
PTPM – 5 yr ave	02.90%       Trend n/a	Same        Trend even	Same          Same	02.8%                 Trend n/a
ROE – 5 yr ave         End Equity	12.15%         Trend n/a	12.1%         Trend up	Same          Same	Not Included
ROE – 5 yr ave         Start Equity	Not Included	13.1%             Trend up	Same         Same	13.0%              Trend n/a
Debt to Equity – 5 yr ave	Not Included	14.4%             Trend up	Same         Same	Not Included

SSG by CalvinG [CG] :

– CG’s SSG is from BI’s First Cut where members can upload their stock studies on a two-page form that explains their judgments.  He also used BI’s Online SSG which is much more limited than SSG software. 

** The Online SSG only projects growth from the last Fiscal Year, has only one method for Forecasting the Low Price, and does not use the Relative Value-Projected Relative Value metrics.

– CG’s SSG is unremarkable for the most part and he makes conservative judgments throughout, but does not provide an explanation or reason for any specific decision.

– Two things are notable: his Forecast Low Price and his Final Recommendation:

** Calvin-G’s Forecast Low Price ($43.65) was very close to the current price for COST ($47.00) and explains why he got such a high Upside-Downside Ratio (8.88).  Sadly, the Online SSG offers no options for the Low Price whereas my SSG software provides four choices.

** First Cut asks for a final recommendation and CG’s was BUY even though his SSG did not satisfy the BUY criteria of at least 15.0% Total Return.

Armin’s  SSG-1 and SSG-2:

– When I did my SSG, Value Line’s 5.50% EPS estimate was atypically low compared to the other five analysts I checked: FactSet CallStreet via CNN Money was high at 13.00%, S&P was 12.90%, Zacks.com was 11.57%, Reuters.com was 11.46%, and Reuters-Thomson via YahooFinance was 11.30%.  The average of all six was 10.95% and, without VL, was 12.05%.

** I estimated 9.00% EPS, well below the analysts.  My resulting High EPS ($4.47) combined with my Projected High PE (20.0) gave me a Forecast High Price of  $80.00 that was at the top of VL’s $65-80 estimate.  I almost never want to substantially exceed VL, and then only if I believe I have a good reason.

** Unlike the Online SSG, I had the opportunity to chose the 52 week low as my Forecast Low Price ($30.20) which resulted in an Upside-Downside of 4.2 in Arrmin-1. I also had an open-ended option which allows me to enter any amount I choose.

– Armin-1 was not a SSG Buy because its 12.1% Total Return did not satisfy the minimum 15.0% criterion even though its 4.2 Upside-Downside passed muster.

– Armin-2 was a SSG Buy because its 15.2% Total Return and 5.5 Upside-Downside satisfied the minimum criteria.  The only judgment I changed in Armin-2 was that growth was projected from the last Fiscal Year instead of the last Quarter.

** Armin-2 illustrates an important point: projecting growth from the last FY in a recessionary market ignores COST’s last 9 months of declining performance and results in an unreliable and unrealistic analysis.

Take Stock:

Take Stock is a one-click computerized program at the StockCentral web site that allows no judgment by the user and is designed to produce a conservative result. 

–  Its Forecast High Price of $109.24 was $29/share or a whopping 37% greater than the high end of VL’s $65-80 High Price estimate.

– Its Forecast Low Price of $48.69 was higher than COST’s current price of $46.24 which Take Stock permits, but which seems like conceptual idiocy to me since a Low Price that’s not “low” makes no sense.

– Its Quality rating was 3.2, which is unsatisfactory, with 3.4 the minimum required to pass muster while a 6.7 is desired out of 10 maximum.  S&P, on the other hand, gave COST a grade of A- for quality, third highest out of 8 ratings.

QUESTIONS:

(1) Do you think Take Stock produced a conservative result, and why or why not?  Was that result reasonable in your judgment, and why or why not?

(2) Do you think COST is a SSG Buy, and why or why not?

(3) Which of the three different Projected High PEs (18.0, 20.0, 24.4) do you agree with and why?  Is there another figure you would use and why?

I’m trying to encourage some discussion and would appreciate your answers to one or more of these quations as a comment in the box below .

 

 -Armin

====================================================================================

The following comments were posted on the BI Discussion List which WordPress won’t let me publish as a comment so I am posting them here: 

 

Hey Ray:

You wrote: << It is my understanding that the Value Line “2012-2014 PROJECTIONS” are for the middle, 2013 (4 years)….if my understanding is correct, the Value Line Low & High of $65 & $80 at 4 years would be $71.50 & $92.00 at 5 years (expanding at annual rates of 10% (Low) & 15% (High).
 
I currently expand Value Lines High & Low another year (to 5 years) when checking with my SSG on a Company.  [AF emphasis]>>

 (1) VL manuals, free to the public, consistently say that its projections are for 3 to 5 years with no elaboration.  See: The Complete Overview of the Value Line Investment Survey and In Depth Guide to Reading a Value Line Research Report, both available at no charge from

 http://www.valueline.com/sup_howtoinvest.html

 – You take 3 to 5 years to mean 4 years while I construe it to mean 3 and 4 and 5 years, that is I believe VL projections relate to a three year period.

 (2) I think VL intends its projections to be like ball-park approximations because long-term estimates are notoriously inaccurate.  VL is deliberately imprecise and uses a dollar range (for COST, $65-80) and a date range (for the next 3-5 years).

 – What makes you think that VL projections are for four years?  Do you have any authority to point us to?

 (3) To compare your SSG for COST to VL, you expand VL’s $65 – 80 estimated High Price range by tacking on an additional year which works out to $71.50 – 92.00.

 – Do you do the same sort of expansion if you use VL’s estimated Tax Rate and/or shares outstanding as part of your SSG’s Preferred Procedure?

 ** Cy Lynch did NOT do any expansion when he used VL estimates in his recent PP articles in Better Investing magazine. See: http://www.betterinvesting.org/Members/Tools/Articles/Archives/PrintMagazine/Authors/LynchCy/0309grstks.htm

 ** Brian Altschul and Gary Ball did NOT do any expansion when Brian used VL estimates in his recent BI Online Stock Study of W. W. Grainger (GWW) and when Gary used VL estimates in his study of Danaher (DHR). See

 http://www.betterinvesting.org/Members/Tools/Stock+Studies/gww.htm

http://www.betterinvesting.org/Members/Tools/Stock+Studies/dhr.htm

** Bonnie Biafore did NOT mention any sort of expansion when she discussed VL in the BI-NAIC SSG Handbook (2003 edition, pp 39-45)

 – VL makes more than 20 estimates for next 3 to 5 years and I don’t think you can pick-and-choose which you will expand and which you won’t.  Moreover, I think these several applications and discussions support my understanding of VL’s 3-5 year projection period.

 (4) Because VL is silent, opinions can differ on whether VL can be interpreted to mean 4 years or 3 to 5 years.  But that is an issue separate from whether it is appropriate toexpand VL’s projections by adding an additional year.  In that regard, I know of no one who has ever added an extra year to VL projections and increased its High Price estimates.

(5) Maybe some of the gurus here might offer their thoughts if you start a new thread (such as: VL Question).  You could also ask VL for clarification and, if you get any answer, please share it with us.

 Armin

=========================================

Armin,

 It is my understanding that the Value Line “2012-2014 PROJECTIONS” are for the middle, 2013 (4 years).

 
Looking at COSTCO: Value Line May 8, 2009

 Current $47 to Low of $65 would be 11.5% Annual return in 2012 (3 years) & 6.5% Annual return in 2014 (5 years).

Current $47 to High of $80 would be 19.0% Annual return in 2012 (3 years) & 11.5% Annual return in 2014 (5 years).

That’s a spread of 19.0% to 6.5% of 12.5%, rather large spread for predicting future “Annual Total Return”.
 
Also if my understanding is correct, the Value Line Low & High of $65 & $80 at 4 years would be $71.50 & $92.00 at 5 years (expanding at annual rates of 10% (Low) & 15% (High).
 
I currently expand Value Lines High & Low another year (to 5 years) when checking with my SSG on a Company.
 
Thanx in advance for any different insight on this subject,

 Ray

Banking On Bard (BCR)

C. R. Bard (BCR), in business for over 100 years, makes a wide variety of medical-surgical supplies and instruments.  According to Value Line, Bard has four core segments: Urology (29% of 2008 sales), primarily Foley catheters; Vascular (26%), stents and angioplasty & angiography catheters; Oncology (26%), specialty catheters & ports, other related products and test materials; and Surgical Specialties (15%).

– Bard’s 2008 Annual Report explains that the company’s EPS growth was above its 14% target for the sixth consecutive year and that it raised its dividend for the 37^th consecutive year. Some 80% of BCR’s 2008 Sales came from products that were number one or two in their respective markets.  And, Bard’s products are sold in over 100 countries and it will be expanding to China and Brazil in 2009.

– I used the Bob Adams one-click spreadsheet to analyze Bard’s 2008 Annual Report and found 11 Bullish results (good things) and 5 Bearish results (not so goods), one red flag (cash flow growth is less than sales growth), and an overall score of 61 out of 100. You can get Bob’s free spreadsheet and a summary of its many features by going to my Favorite Links page: click here .

– Bard was this month’s Online Stock Study at the Better Investing website.  These studies complete a SSG in about one hour with all judgments made by consensus decision-making.  The study materials (SSG, audio-video presentation, presentation slides, and Value Line report) are available to members at the BI website.  And, all of the past monthly studies are also archived and available to BI members.

** Bob Mann, a volunteer educator with the BI Southeastern Michigan Chapter and a volunteer administrator at the CompuServe Investing for Growth Forum, led the study.  Thanks Bob for a super study.

– Below is a table that compares the Consensus SSG with my SSG and with Take Stock.  I’ve also added an earlier SSG by Bob that came from BI’s First Cut page where members  can up- and download SSGs on a two-page form that explains their judgments. 

** I’m a big fan of the monthly Online Stock Studies and First Cut; you can check them out with a free, 30-day trial membership by clicking the link above and going to my Favorite Links page which has more info on BI.

** After the table, I discuss all five judgments of the Consensus SSG.  That was what most readers wanted according to the last poll I took.

Bard, C. R. (BCR)	Bob Mann (First Cut)	Consensus SSG	Armin	Take             Stock
Date	12-31-08	5-25-09	5-25-09	5-25-09
Data	S&P	Same	Same	Hemscott-Morningstar
Price	$84.26	$71.46	Same	Same
52 week High & Low Price	$101.61 &    $70.00	Same &        $68.94	Same &           Same	n/a
Project Growth   From End of	Last             Quarter	Same	Same	Last                 Fiscal Year
Last Q of data	Q3 ending  9/30/08	Q1 ending     3/31/09	Same	Same
Sales Growth	12.00%	9.00%	10.00%	10.40%
EPS Growth	12.00%	9.00%	10.00%	05.20%
High PE	22.0              (Alt-M)	21.8	19.0	22.7
High EPS	$7.53	$7.03	$7.36	$5.23
ForecastHigh Price	$165.70	$153.30	$139.80	$118.58(~$22/sh        < VL)
Value Line Estimated High Price= $140-175 as of 2-27-09                        and  $140-170 as of 5-29-09
Low PE	14.4               (Alt-M)	Same	13.8	15.9
Low EPS	$4.27           (TTM)	$4.57           (TTM)	Same	$4.11
Forecast              Low Price	$61.50          (low PE x         low EPS)	$65.80         Same	$55.20            (80% x 52         week low)	$65.35               (low PE x          low EPS)
Upside/Down	3.6	14.4	4.2	7.7                  (imputed)
Total Return	15.7%	17.2%	15.2%	11.6%
SSG Buy Under	n/a	n/a	$64.81	$61.67
RV/PRV(no outs)	94.3/84.3	73.2/67.4	Same/66.7	n/a
Quality	n/a	n/a	S&P = A	TS 2.6         unacceptable
PTPM – 5 yr ave	23.7%           trend up	25.0%          trend up	25.0%              trend up	24.4%          trend n/a
ROE – 5 yr ave    End Equity	n/a	n/a	20.7%              trend up	n/a
ROE – 5 yr ave    Start Equity	20.1%             trend up	21.7%            trend even	23.7%                trend even	23.9%                trend n/a
Debt to Equity      – 5 yr ave	n/a	n/a	07.2%              trend even	n/a

Consensus SSG:

– The first thing Bob did was evaluate the quality of Bard.  While S&P gave BCR an “A” rating, Bob also wanted to see what the SSG showed.  He concluded that Bard was a quality company after looking at three indicators: low debt (7.0% debt to capital, much less than 33.0% guideline); quality historic growth (up, straight and parallel trend lines in SSG Section 1); and quality management (up or even PTPM and ROE trends in SSG Section 2).

** Bob would not complete any SSG if the company did not pass these three tests

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.  On the other hand, I am willing to make an exception for a PTPM or ROE downtrend if the company substantially exceeds its industry average.  I did that, and explained why, in my last post: Gauging Growth at Gilead (GILD).

(A) Estimating Future Sales Growth:

– For the first SSG judgment call, Bob gave the group four options to estimate Bard’s Sales growth for the next five years: 10.4% (10 year historic growth), 16.2% (4 year historic growth), 9.0% (next 3 year estimate from the S&P Stock Report), and 2.1% (latest quarter).  There also was a fifth option (choosing none or submit your own pick) for all five SSG judgments) which I’m not going to mention again.

** The consensus decision was 9.0%, the most conservative annual option, from the S&P estimate. 

(B) Estimating Future EPS Growth:

– Participants were also given four choices to estimate EPS growth for the next 5 years: 9.0% (same as the Sales growth choice), 14.5% (5 year historic growth), 13.0% (next 3 year estimate from the S&P Stock Report), and 10.4% (latest quarter). 

** The consensus was 9.0%, same as the Sales growth choice.

(C) Projecting the High PE:

– The group was offered four options: 21.8 (average of the 5 lowest years), 22.8 (High PE from the most recent year), 18.0 (2 x 9.0, two times the projected EPS growth or a PEG of 2), 13.5 (1.5 x 9.0, a PEG of 1.5).

** The group chose 21.8, the average of the 5 lowest years.

** This choice is Toolkit 5’s Alt-M command which is usually the most conservative of the four options offered by the software.

(D) Projecting the Low PE:

– Bob gave the participants four choices: 14.4 (average of the 5 lowest years), 15.7 (low PE from the most recent year), 16.4 (ten year average), and 9.0 (1.0 x 9.0, a PEG of 1.0).

** The consensus choice was 14.4, the average of the 5 lowest years which is also from the Alt-M command.

(E) Projecting the Low Price:

– For the last SSG judgment call, the group was given five options, the first four of which were the standard choices from the TK 5 software: $65.80 (low PE x low EPS), $61.50 (average low price in last 5 years), $68.90 (recent severe low price), $54.60 (price the dividend will support), and $57.20 (the open-ended “other” option which Bob individualized as 80% of the current price).

** The consensus choice was $65.80 (low PE x low EPS).

(F) SSG Results:

– Bob uses three tests to determine if the stock is a SSG Buy: an Upside/Downside Ratio of 3.0 or greater (Bard’s U/D was 14.4, well above the minimum); a Total Return of 15.0% or greater (Bard’s TR was 17.2%); and a Relative Value between 85-100 (Bard’s RV was 73.2 and did not satisfy Bob’s criteria).

** The SSG Handbook from BI/NAIC says that a “Relative Value between 85-110 is ideal” (page 113, 2003 edition) which suggests, at least to me, that RV is not a mandatory criteria.

** I am not a fan of the RV or Projected RV: they turn on the outliers eliminated in SSG Section 3 (you and I may make different choices which are never revealed) and is also an unreliable indicator in a Bear market like our current one where the price (and, as a result, the PE and RV) have fallen considerably.

– I always like to compare the SSG’s Forecast High Price ($153.30) to Value Line’s estimated High Price ($140-170) which I use as one benchmark to judge reasonableness.  If my Forecast High Price was substantially higher or lower than VL’s estimate (as is the case here with Take Stock, but not with the Consensus SSG), and I didn’t have a good reason supporting my opinion, I would reconsider my judgments: See: Determining What’s Reasonable and What’s Not

– Bob’s earlier SSG used almost the same judgments, but got a much higher U/D (14.4 vs 3.6) primarily because Bard’s price had fallen by $13 per share in the intervening five months.

Armin’s SSG:

(A) Estimating Future EPS Growth:

– When I did my SSG, the six analysts I always check were closely estimating long-term EPS at an average of 13.92% with Zacks.com high at 14.20% and Value Line low at 13.00% (VL has since lowered its estimate slightly to 12.50%).  S&P and FactSet CallStreet via CNNMoney were both 14.00% and Reuters.com and FirstCall via YahooFinance were both 14.17%.

** At Reuters, 8 analysts contributed to the consensus estimate and ranged from a high of 16.0% to a low of 13.0%.  At CNNMoney, 6 analysts ranged from a high of 15.0% to a low of 13.0%.

** I estimated 10.00% EPS, well under the analysts, and the combination of my EPS estimate and High PE resulted in a $139.80 Forecast High Price, at the very low end of VL’s estimated $140-175 High Price. 

** I’m comfortable with my conservative SSG judgments especially, as here, when I know next-to-nothing about the company.

(B) Bard’s PTPM and ROE vs Industry Averages

– S&P places Bard in the Health Care Equipment industry and BCR is better than its 5 year industry average in terms of Pre-Tax Profit Margin (25.0% vs 16.8%) and Return on Equity (20.7% or 23.7%, depending on how ROE is calculated, vs 14.00%).

– Hemscott-Morningstar places Bard in the Medical Instruments and Supplies industry which has 118 companies.  With Hemscott data:

** Bard’s Pre-Tax Profit Margin ranks ninth, is slightly better than its industry average (24.3% vs 22.8%), but the industry average is skewed high (one company has a 311.4% PTPM).

** Bard’s Return on Equity ranks eighth, is worse than its industry average (20.8% vs 31.9%), but the industry average is also skewed high (two companies have a 690.5% and 100.5% ROE).

– For more on industry info, which can be confusing, see Investigating Industry Info.

(C) SSG Results:

– My SSG satisfied the Buy criteria with a 4.2 U/D and 15.2% TR and my Forecast High Price was at the very low end of VL’s estimated High Price.

** VL’s estimated High Price is for the next 3-5 years and I think it is an appropriate benchmark for our SSGs because it is for the next 5 years (and 4 as well as 3 years).  Moreover, I consider a SSG Forecast High Price to be unreasonable only if it substantially exceeds or falls below VL and only if I have no good reason supporting such a judgment.  Further research can provide a good reason and VL does not always have the best judgment. 

** It looks like many SSGs will satisfy the minimum BUY criteria (TR = 15%, U/D = 3.0) as BCR’s price has fallen 15% in the last 3 months since VL’s February report.

Take Stock:

– Take Stock is a computerized, one-click program at the StockCentral website that is designed to produce a conservative result with no judgment by the user.

** It estimated extremely low EPS growth (5.2%) compared to the analysts (13.92% average) which resulted in an extremely low Forecast High Price, $22/share under the low end of VL’s estimated High Price.  As a result, Take Stock got a low TR of 11.6% which does not satisfy the Buy criteria.

** Tale Stock’s Quality rating was 2.6, or unacceptable, as a minimum of 3.4 is required to pass muster and 6.7 is desired.  On the other hand, S&P rated Bard an “A”, the second highest of its 8 grades.

 

-Armin

Gauging Growth at Gilead (GILD)

[AF: SSG Armin-2 revised 6-9-09]

Gilead Sciences (GILD) is a pharmaceutical biotech that makes drugs primarily to treat viral diseases.  It concentrates on four areas: HIV/AIDS which is by far its largest segment, liver diseases, cardiovascular, and respiratory.

Business Week reported that GILD’s top three HIV drugs generated 84% of its sales in 2008.  It also wrote that new cases of HIV in the U.S. are estimated at 56,000 per year, with only 50% receiving treatment, and that GILD has solid growth opportunities. 

Company Background

– Gilead was the best performer in Business Week’s 2009 rating of “The BW 50”, March 26, 2009.  The magazine combined Return on Investment and Sales growth to come up with its rating.  GILD ranked first in ROI (48.6%) and fifth in Sales growth (38.2%) to wind up in first place.

– The company’s growth has been explosive, but is slowing as GILD matures: growth was 53% Sales and 169% EPS over the last 10 years, 42% Sales and 44% EPS for the last 5, and 33% and 29% over the last 3 years (using S&P data).  In 2008, both Sales and EPS growth were 26%.

– GILD was the Stock to Study in the April 2009 issue of Better Investing magazine which reported that the company spent about 14% of it sales on R&D.  It is also spending $1.4 B to buy CV Therapeutics which develops drugs for cardiovascular diseases. 

– Morningstar reported that even though GILD has 10 years remaining until key patents begin to expire, it is diversifying with the $2.5 B acquisition of Myogen in 2006 and the pending $1.4 B acquisition of CV Therapeutics.

– Analyzing the Annual Report, the one-click spreadsheet by Bob Adams, gave GILD’s 2008 A.R. a total score of 49 out of 100, identified 3 red flags, 16 green flags (very goods) and found 9 bullish and 8 bearish results. The red flags were that the cost of sales was up 47% and growing faster than sales, that long-term debt at 31% was more than BI’s 25% guideline, and that the price to sales ratio was higher than its industry average.

** To get this free and easy to use spreadsheet and a summary of its many features, click here to go to my Favorite Links page.

SSGing GILD:

– The New Jersey Stock Study Group recently analyzed GILD.  It’s SSG is available from BI’s First Cut section where members can up- and download SSGs on a two page form that explains each judgment.  The Study Group’s discussion was led by Brian Altschul who also led the BI Online Stock Study on W.W. Grainger (GWW), see: Grappling With Grainger.

– Here’s a table comparing the Study Group’s SSG with two of mine and with Take Stock.  Both of my SSGs contain the sane judgments, but Armin-1 uses S&P data while Armin-2 uses Hemscott data.

[AF: I revised Armin-2 below on 6-9 so that it uses the same price as Armin-1 which then changed some of the SSG results.  Jim Thomas, on the BI Discussion List, pointed out that these prices were initially different and confused the comparison.]

Gilead Sciences(GILD)	N. J. Stock          Study Group	Armin-1	Armin-2	Take             Stock
Date	5-15-09	5-29-09	Same	Same
Data	S&P	S&P	Hemscott-Morningstar	Same
Price	$44.01	$42.13	$42.13	$42.02
52 week High &  Low Price	$57.63 &             $35.60	Same &         Same	Same &         Same	n/a
Project Growth From End of	Last                         Quarter	Same	Same	Last                Fiscal Year
Last Reported Quarter	Q 1                   ending  3-31-09	Same	Same	Same
Sales Growth	14.00%	14.00%	Same	20.00%
EPS Growth	11.50%	12.00%	Same	20.00% init   19.36% final
High PE	25.0	22.0	Same	28.6
High EPS	$3.83	$3.90	$3.89	$5.11
High Price	$95.70                   (12% > VL)	$86.00           (01% > VL)	$85.60	$145.97           (72% > VL)
Value Line Estimated High Price = $65-85 @ $47.43 as of 4-17-09  and        $65- 85  @  $49.63 as of 1-16-09
Low PE	15.0	14.0	Same	17.5
Low EPS	$2.11	$2.12	$2.21	$2.21
Low Price	$31.60                      (low PE x                 low EPS)	$31.10           (low PE x      low EPS)	$30.90 (Same)	$38.18             (low PE x     low EPS)
Upside/Down	4.2	4.0	3.9	27.1                (imputed)
Total Return	16.9%	15.3%	15.2%	28.3%
SSG Buy Under	n/a	$42.76	$42.56	$65.47
RV/PRV (no outs)	56.6/50.8	73.4/65.4	74.3/66.2	n/a
Quality	n/a	S&P = B-	n/a	TS = 6.8         (excellent)
PTPM – 5 yr ave	53.8%                  Trend down	Same &         Same	50.2%           Trend up	50.2%             Trend n/a
ROE – 5 yr ave Ending Equity	n/a	40.9%           Trend up	41.4%           Trend up	n/a
ROE – 5 yr ave Starting Equity	52.3%                    Trend up	Same &        Same	52.6%             Trend up	52.6%              Trend n/a
Debt to Equity –  5 yr ave	33.5%                    Trend up	30.6%            Same	30.5%            Trend up	n/a

SSG by the New Jersey Stock Study Group:

(A) Sales Growth

– The Study Group projected 14.00% future Sales growth as a consensus decision with individual estimates ranging from 13 to 17%.  No reason was stated for choosing 14%.

** As GILD has grown larger, its Sales growth has steadily declined from 53% over the past 10 years to 26% in 2008. 

 ** The First Cut write-up mentions that Value Line’s estimate was 14.50%, but that actually was for Sales per share as VL makes no estimate for Sales growth.  However, we can imply a Sales growth rate from VL’s dollar estimates of 10.90% (traditional method) to 13.45% (VL’s method).

** Estimating future Sales growth is difficult because, unlike EPS, there are few websites that provide any benchmarks.  The only long-term Sales estimates I know of are VL’s implied growth of 10.9-13.5% , Zacks.com’s 42.83% (which seems way unreliable), and Morningstar’s analyst report that estimates 11.0% over the next 10 years. . 

(B) EPS Growth

– The Group projected 11.50% EPS growth also as a consensus decision with individual estimates ranging from 10 to 17%.  The 11.50% came from using the Preferred Procedure.

** The PP was based on the following estimates for the next 5 years: 14.00% Sales, 45.80% Pre-Tax Profit Margin (down from the 53.8% default), 30.00% Tax (up from 26.1% default), and 906.5M shares (the default).

** PTPM has been declining from 57.5% in 2005 to 51.3% in 2008, so using 45.80% anticipates a huge decline; increasing the Tax Rate to 30.00% is the same as VL’s estimate; and the 906.5M shares estimate ignored VL’s estimate of 860M shares.

(C) Projected High and Low PEs

– The Study Group saw that High PEs had declined in the last several years and thought that trend would continue as the company was maturing.  So, it chose 25.0 in order to be conservative.  Similar reasoning led the Group to choose 15.0 as the Low PE.

(D) SSG Results

– The combination of estimating 11.50% EPS growth and a 25.0 High PE resulted in a Forecast High Price of $95.70, some 12% greater than the high end of VL’s $65-85 estimate.  I never want to substantially exceed VL (like Take Stock here) and anything more than 15-20% above VL would make me rethink my judgments.

** GILD was a SSG Buy for the New Jersey Study Group with a 4.7 Upside-Downside Ratio and a Total Return of 16.7%, both of which were well in excess of the 3.0 and 15.0% minimum criteria.

Armin’s SSGs:

(A) EPS Growth

– When I did my SSG, Value Line had recently lowered its long-term EPS estimate from 17.50% to 12.00% without explanation.  VL’s change was huge, but its High Price estimate was not changed.

– The 5 other analysts I always check were very close in estimating long-term EPS at an average of 17.09% with Reuters Thomson via YahooFinance high at 17.52% and Zacks.com low at 16.95%.  Reuters.com was 16.99%, and S&P as well as FactSet Call Street via CNN Money were 17.00%. 

** The Reuters estimate was from 14 analysts who ranged from a high of 23.0% to a low of 13.10%.  FactSet CallStreet’s estimate was from 9 analysts who ranged from a high of 23.0% to a low of 15.0%. 

** The average of all 6 estimates less two Standard Deviations was 14.14% (which Excel easily calculated) and my rule-of-thumb is anything below two SDs is usually too conservative and unreasonably low.  Here, however, the lowest of all analysts was Value Line’s 12.00% which I decided to use.

** Unlike the Study Group, I stopped using the Preferred Procedure because it involves too many estimates and too much guesswork for me.  The Sales estimate is critical to the PP and, if you start (too) low, you’re bound to end up (too) low.  See: Pondering the Preferred Procedure.

(B) PTPM and ROE vs Industry Averages

– S&P places Gilead in the Biotechnology Industry and, as of 5-6-09, GILD was way better than its industry PTPM average (53.8%, trending down vs 24.4%) and slightly worse than its industry ROE average (40.9%, trending up vs 46.0%)

** A PTPM downtrend is usually a red flag indicating poor quality.  However, I’m not bothered by GILD’s downtrend in PTPM because its PTPM is so much better than its industry average.  GILD is so much better (53.8% vs 23.4%) that I’m concerned it might be it making excessive profits on its HIV drugs.

– Hemscott-Morningstar places GILD in the same industry and its PTPM ranks 3^rd out of 228 companies.  (The industry average is skewed because of one company, ACHN, with an incredible 3514.6% PTPM).  GILD’s ROE also ranks 3^rd.

(C) Debt to Equity

– Even though the Study Group and Armin-1 both used S&P data, our Debt to Equity was inexplicably different from 2005 through 2008. The Study Group’s SSG used Toolkit 6 while I used TK 5, and both should get the same result as we used the same data.

(D) SSG Results

 – Armin-1 with S&P data had a Forecast High Price of $86, just 1% more than VL’s estimate, and resulted in a SSG Buy with a 4.0 U/D and a 15.3% TR.

 [AF: After I corrected the price of Armin-2, which uses Hemscott data, it was also a SSG Buy with a 3.9 U/D, 15.2% TR and a Forecast High Price of $85.60.]

Take Stock:

– Take Stock is a computerized program at the StockCentral website that is designed to produce a conservative result with one click and no judgment by the user. It produces an almost-SSG, and does not use the U/D or RV/PRV concepts

 (A) Final Results

– Take Stock’s $145.92 Forecast High Price was a whopping 72% higher than VL’s estimated $65-85, unreasonably high in my judgment.  That’s because its 19.36% estimated EPS was well in excess of any analyst and its 28.6 Projected High PE was also high by comparison.  See: Determining What’s Reasonable and What’s Not.

– I imputed a 27.1 U/D which is also way high primarily because Take Stock’s Forecast Low Price ($38.18) was very close to GILD’s current price ($42.02).  Take Stock’s design even allows its Low Price to exceed the stock’s current price which is a SSG No-No according to the BI/NAIC SSG Handbook.

QUESTIONS:

– Please help me answer these questions:

(1) The Study Group estimated 11.50% EPS growth based on its Preferred Procedure and I used 12.00% based on VL’s estimate because it was the lowest of the six analysts I checked.  What EPS estimate would you use and why?

(2) How would you learn if GILD’s PTPM was excessive and/or exploitive?  Can you ascertain what’s a typical or average profit on new prescription drugs??

(3) Does anyone have a clue as to why the Study Group got a Debt to Equity ratio (33.5%) that is different from what I got (30.6%) even though both SSGs used the same S&P data???

[AF: Jim Thomas also answered this question by explaining that the TK 6 software, which the Study Group used,  calculates Debt to Equity differently than TK 5 which I use. That difference makes meaningful comparisons of Debt to Equity impossible.  Subsequently, Douglas Gerlach explained (in a 6/16 webinar at StockCentral) that TK 5 and TK 6 would be made identical with respect to Debt to Equity after TK 6.2 is issued in the next few weeks.]

– Armin

=========================================================================================

[AF: The following was Brian Altshul’s response by e-mail which WordPress won’t allow me to post as a comment.]

Interesting Armin. I’ll look more into the debt to equity ratio and talk about that in my classes. I think that was the first SSG we did using TK6.

As for your assessment, I’ll make several points in rebuttal.

VL doesn’t estimate 5 years out, so your comparison of the VL price isn’t totally accurate. It states that it’s estimates are all 3-5 years, making the use of the figures additionally problematic. I am personally comfortable with your use of $88 as your high price, it is in fact right around double the price at the time of the study. But comparing it with VL estimates isn’t all that useful other than a point of information.

You complain about the application of 14% sales, but you have used the same on both SSGs. The decision was a consensus of the group. There was a very narrow range amongst the group.

The profit margin was lowered in an effort to be conservative, but you are correct in saying that this could be a signal of eroding management. In our research we saw comments from management that competition in their main areas may cut into their margins in the future. That was part of the rationale for lowering it. As for the high profit margins, I think this is typical of young drug companies with immature drug product lines. As the products age, the margins decline. They also justify their profits citing high R&amp;D costs to bring the products to market, the many failures they typically experience (even if it’s not the case) and the R&amp;D expenses in the future. I won’t comment on the ethics of all of this, but it is the current system.

As for the use of the Preferred Procedure, I think it’s an excellent tool, but as with any tool care must be taken. There are times when it is unusable.

You question the PP, but the results were very similar to your own. If sales will be 14%, what will lower earnings to 12% other than either higher expenses or lower margins? Sure, taxes are a possibility, but will they skyrocket to a % beyond rates of other US corporations? I would doubt that. I would say that you agree on a lowering of the profit margin.

Lastly, I’ll point out that this SSG was a consensus decision and therefore blame the group on the final product. 🙂

I think you make several interesting points. Maybe you’ll consider sending your SSG in for a First Cut?

Feel free to publish my comments on your site without revision if you like.

Best regards,
Brian

Sent from my BlackBerry® smartphone with Nextel Direct Connect

——————————————————————————–
From: Armin Fields
Date: Thu, 11 Jun 2009 11:57:02 -0700 (PDT)
To:
Subject: GILD

Hey Brian:

Did you know that Toolkit 6 calculates Debt to Equity differently than Toolkit 5?

That makes comparisons of D/E unnecessarily confusing.

I uncovered this when I compared the New Jersey Study Group’s SSG (TK 6) for GILD, which I got from BI’s First Cut page, with mine (TK 5).

If you’re interested in my assessment, check out:

Gauging Growth At Gilead (GILD)
https://arminfields.wordpress.com/2009/06/01/gauging-growth-at-gilead-gild/

Armin

Discovering Danaher (DHR)

Acquisitions are the primary driver of growth at Danaher Corp (DHR), a manufacturing conglomerate.  In the past five years, 14.5% of DHR’s sales growth has been due to acquisitions, some 75% of its total sales growth according to Wikinvest.  Eighteen companies were acquired in 2008, with Tektronix the largest to date ($2.8 B).  S&P reports 12 acquisitions in 2007 and 11 in 2006. 

DHR was this month’s Online Stock Study at the Better Investing website.  These studies complete a SSG in about one hour with online participants making the judgments by consensus.  This one was led by Gary Ball, an experienced volunteer educator, retired investment professional and member of BI’s Board of Directors. Thanks Gary for an excellent SSG study.

Company Background:

Danaher manufactures mostly high-tech equipment and operates in four segments: Professional Instrumentation (38% of 2008 Sales), Medial Technologies (26%), Industrial Technologies (26%), and Tools and Components (10%). Tektronix, before its acquisition, was the market leader in high precision oscilloscopes and DHR also makes Craftsman hand tools sold by Sears.

Danaher’s strategy is to buy underperforming companies and make them run more efficiently. Morningstar explains that DHR acquires companies that possess proprietary technology and a strong market position.  It focuses on niche markets that permit economies of scale and then uses its Danaher Business System to improve profitability and cash flow, and will divest if the desired return on investment is not achieved.

The Bob Adams one-click spreadsheet analysis of DHR’s 2008 Annual Report shows a total score of 63 out of 100 with 11 Bullish results (good things such as decreasing accounts receivable, inventories, and debt) and 5 Bearish results (not-so-good things such as ROE is deemed inadequate).  You can get this free, super-duper spreadsheet and a description of its many features by clicking here.

Here’s a table comparing the Consensus SSG to my two SSGs and to Take Stock.  The only judgment that’s different between Armin-1 and Armin-2 is my estimate of EPS growth. 

Danaher Corp          (DHR)	Consensus       SSG	Armin-1	Armin-2	Take              Stock
Date	5-5-09	5-8-09	Same	5-9-09
Data	S&P	Same	Same	Hemscott-
Price	$61.60	$61.38	Same	$61.38
52 week High &            Low Price	$85.00 &           $47.20	Same &         Same	Same &        Same	n/a
Project Growth From End of	Last               Quarter	Last               Quarter	Same	Last                     Fiscal Year
Sales Growth	5.00%	9.00%	Same	14.90%
EPS Growth	5.50%	8.00%	11.00%	06.10%
High PE	17.1	18.0	Same	23.0
High EPS	$5.30	$5.97	$6.84	$5.28
High Price	$90.60                 ($4.40/sh < VL’s low end est)	$107.50	$123.10	$121.37
Value Line Estimated High Price = $95-125 @ $54.42 on 4-24-09
Low PE	11.2                (lowest in last    5 years)	11.2           (Same)	Same	16.2
Low EPS	$3.47	$4.23	Same	$3.92
Low Price	$47.20          (recent severe low price)	$47.20        (recent severe low price)	Same	$63.50           (exceeds the current price)
Upside/Down	2.0	3.3	4.4	impossible to calculate
Total Return	8.2%	12.0%	15.1%	17.6%
SSG Buy Under	n/a	$53.78	$68.40	$61.22
RV/PRV (no outs)	77.6/73.4	77.0/71.4	Same/69.5	n/a
Quality	n/a	S&P = A+ (best)	Same	TS = 2.1(unacceptable)
PTPM – 5 yr ave	15.2%               trend even	Same &         Same	Same &       Same	14.9%                 trend n/a
ROE – 5 yr ave            with Ending Equity	14.9%             trend down	Same &        Same	Same &        Same	n/a
ROE – 5 yr ave            with Starting Equity	n/a	18.0%          trend down	Same &        Same	17.8%                 trend n/a
Debt to Equity –              5 yr ave	n/a	27.4%          trend down	Same &         Same	n/a

All 5 judgments by the Consensus SSG are discussed below so let me know, in the poll at the end,  if you think this post is too long.  The Consensus had a few surprises which are indicated in blue highlighting so they’re easier to spot.

CONSENSUS SSG:

Future Sales Growth:

– Gary gave the group four choices to estimate future Sales growth: 17.00% (last 10 year average), 15.00% (last 5 year average), 5.00% (Gary’s estimate), and 3.50% (VL’s estimate).  Another choice for all of the judgments was “None of the Above” which I won’t report.

 – Value Line’s 3.50% estimate was actually for Sales/Share as VL makes no estimate of Sales growth.  However, based on VL dollar estimates, we can imply a Sales growth rate of 1.83% (traditional method) to 3.81% (VL’s method).

 – Gary’s 5.00% estimate was based on YahooFinance’s Sales growth estimates for this year and next which he extended for another three years.

– The Consensus choice was 5.00%, Gary’s estimate.

Future EPS Growth:

– The group also was offered four choices to estimate DHR’s future EPS growth: 11.40% (YahooFinance’s long-term estimate for the next 5 years), 5.50% (VL’s estimate), 5.50% (from the Preferred Procedure), and 5.00% (Gary’s estimate).

– Gary did not check other long-term EPS estimates which I discuss under Armin’s SSG.

– The 5.50% Preferred Procedure estimate was based on: 5.00% Sales growth, 14.6% PTPM (down from the 5 year average of 15.2%), 21.0% Tax Rate (VL’s estimate), and 320 M Shares (VL’s estimate).  I stopped using the PP because it involves too many estimates and way too much guesswork; see Pondering the Preferred Procedure.

– Gary’s 5.00% EPS estimate was based on YahooFinance’s EPS growth estimates for this year and next which he extended for another three years.

 –  The Consensus choice was 5.00%, Gary’s estimate.  However, the Consensus SSG inexplicably uses 5.50%.

Forecast High PE:

– Four choices were offered to estimate the Forecast High PE: 22.8 (the 5 year historical average), 22.3 (the 3 year average), 20.9 (from 2008, the lowest High PE in the last 5 years), and 17.1 (based on a PEG of 1.5).

 – The 1.5 PEG was applied to 11.40% future EPS, based on YahooFinance’s estimate,

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which doesn’t seen right to me since the Consensus actually chose 5.00% for DHR’s future EPS.

– The Consensus chose 17.1, but Gary decided to use 20.9 instead , the lowest High PE in the last 5 years.

 Forecast Low PE:

– Four choices were also given to forecast the Low PE: 16.4 (the 5 year historical average), 15.3 (the 3 year average), 11.4 (PEG of 1.0), and 11.2 (from 2008, the lowest Low PE in the last 5 years).

– A 1.0 PEG was applied to 11.40% future EPS estimate from YahooFinance, but the Consensus actually chose 5.00% future EPS.

– The Consensus chose 11.2, the lowest Low PE in the last 5 years.

 Forecast Low Price:

– The fifth and last judgment was to select a Forecast Low Price from the four options offered by the Toolkit software: $28.90 (low PE x low EPS), $52.50 (average low price for the last 5 years), $47.20 (recent severe low), and $47.20 (price dividend will support).

– Gary lowered the low EPS from $4.23 to $3.47 based on YahooFinance’s EPS estimate for this year .

– The Consensus chose $47.20, the recent severe low which was the 52 week low when the SSG was completed on May 5, 2009.

– Whereas the Toolkit software offers four choices for the Forecast Low Price, BI’s Online SSG is much more limited and only offers one choice (low PE x low EPS).  It’s a good thing that Gary used his TK software.

SSG Results:

– As a consequence of these decisions, DHR was not a SSG Buy by the Consensus.  The $90.60 Forecast High Price was slightly below the low end of VL’s estimated $95-125 High Price; the 2.0 Upside/Downside Ratio was well under the 3.0 minimum needed to satisfy the Buy criteria; and the 8.00% Total Return was also well under the 15.00% minimum needed to Buy.

ARMIN’S SSGs:

Future EPS Growth:

– Value Line is currently estimating long-term EPS at 5.50% (down from 8.5%).  VL looks like a low-ball outlier compared to other analysts so I treated it as an outlier and disregarded its estimate.

 – Not only is VL out-of-whack with the other analyst estimates, its report also seems internally inconsistent as it does not expect any slowing of DHR’s acquisition activity, but does expect long-term EPS to drop to 5.50%.

– The five other analysts I always check were estimating long-term EPS at an average of 12.76% with Zacks.com high at 14.25%, and Reuters Thomson via Yahoo Finance low at 11.38%.  S&P was 12.50%, Reuters.com was 12.67%, and FactSet CallStreet via CNNMoney was 13.00%.

– Excel easily calculated that 11.73% was the Average less 1 Standard Deviation and 10.70% was the Average less 2 SDs.  I think reducing the average like this “wrings out” analyst over-optimism and results in a reasonably conservative estimate.

– Historical EPS growth using S&P data has been trending down for the last 6 years from 21.7% to 10.4% in 2008.  For the last three years, EPS growth has averaged 13.9%.

Danaher’s PTPM and ROE vs Industry:

– S&P places Danaher in the Industrial Machinery Industry and DHR is worse than its 5-year industry average in terms of Pre-Tax Profit Margin (15.2% vs 22.0%), but better in terms of Return on Equity (14.9% vs 7.1).

– Hemscott-Morningstar places DHR in the Conglomerate Industry and the company is worse than its 5-year industry average in terms of PTPM (14.9% vs 21.5%) and ROE (14.7% vs 24.2%).

– For more on industry info, which can be tricky, see Investigating Industry Info.

SSG Results:

– With 8.00% as the future EPS growth (Armin-1), my U/D was 3.3 but my TR was only 12.00% which did not satisfy the SSG Buy criteria of 15.00%.  Only when I increased future EPS growth to 11.00% (Armin-2) did my Total Return become 15.10%.

TAKE STOCK:

– Take Stock is a one-click computerized program at the StockCentral website that is designed to produce a conservative result with no judgment by the user.  TS produces an almost-SSG, everything but UD, and RV/PRV.

Forecast Low Price:

– Take Stock’s Low Price ($63.50) exceeds its current price ($61.38) which is permissible under TS, but is a SSG No-No according to the NAIC/BI SSG Handbook.

– TS has only one way to calculate the Low Price (low PE x low EPS) unlike the Toolkit software which offers four options.

– Even though TS doesn’t use the U/D, it can be calculated by hand, but only when the Low Price is below the current price.  Here, it is impossible to calculate and that makes comparisons impossible.

 [AF: An edited version of this Online Stock Study appears in the 10-09 issue of Better Investing magazine]

-Armin

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Analyzing Amedisys (AMED) and Mulling Over More Methods

 

– Amedisys (AMED) provides home health care services, including infusion and respiratory therapy, mostly to Medicare patients as well as hospice services to the terminally ill.  According to the latest Value Line, AMED operates 325 Medicare certified home health agencies and 29 hospices in 30 states, mostly in the south.

 

– AMED’s 2008 annual report shows that the company rates a 54 out of 100 on Bob Adams’ spreadsheet with 6 red flags, 6 bullish results (good stuff), and 9 bearish results (not good stuff).  The red flags include that the cost of sales is up and increasing faster than sales, and that long-term debt to equity is twice the recommended level. 

 

** You can read about this free, super-duper spreadsheet, which needs just the ticker symbol to thoroughly analyze the latest A.R., and get it by going to my “Favorite Links” (click here).

 

– Better Investing’s First Cut page is where any BI member can upload their SSGs along with a two-page form that explains their judgments.  That’s where I got PatL’s SSG on AMED. 

 

** Pat has a unique method for doing his SSGs: after estimating future Sales and EPS growth, he next decides the Forecast Low Price and then uses that to estimate the Forecast Low and High PEs.  In contrast, my more conventional method is to decide the Forecast Low Price as my last judgment call.

 

– Here’ s a comparison of Pat’s SSG with mine and with Take Stock:

 

Amedisys (AMED)	Pat L (from BI’s First Cut)	Armin	Take Stock
Date	3-20-09	4-9-09	4-9-09
Data	Morningstar	S&P	Morningstar
Price	$32.71	$32.89	$32.89
52 week High & Low Price	$67.98 & $25.20	Same & $25.20	N/A & N/A
Project Growth From End of	Last Quarter	Last Quarter	Last Annual
Sales Growth	16.00%	11.00%	20.00%
EPS Growth	14.70% (from the PP)	11.00%	20.00%
High PE	16.0	15.0 (Alt-M)	17.1
High EPS	$6.48	$5.51	$8.02
High Price	$103.68 (9% > VL)	$82.70	$136.92 (44% > VL)
Value Line Estimated High Price = $60-95 as of 3-20-09
Low PE	8.2	7.3 (Alt-M)	6.5
Low EPS	$3.27	$3.27	$3.22
Low Price	$26.81 (Low PE x Low EPS)	$17.60 (70% x 52 week low)	$20.93 (Low PE x Low EPS)
Upside/Down	12.0	3.3	8.7 (imputed)
Total Return	26.0%	20.3%	33.0%
SSG Buy Under	n/a	$33.91	$49.95
RV & PRV (no outs)	N/A & 72.1	59.1 & 53.0	N/A
Quality	Not Rated	S&P = B	TS = 3.2 (unacceptable)
PTPM – 5 yr ave	13.1% Trend varying	13.1% Trend down	13.1% Trend N/A
ROE – 5 yr ave End Equity	13.9% Trend down	14.6% Trend up	N/A
ROE – 5 yr ave Start Equity	N/A	21.9% Trend down	22.0% Trend N/A
Debt to Equity – 5 yr ave	15.6% Trend varying	15.7% Trend up	N/A

 

 

Pat’s SSG:

 

– Pat estimated 16.00% future sales growth based on 20.00% for 2009 and 15.00% internal growth (no acquisitions) for the next 4 years.

 

** AMED’s historical sales growth has been much, much higher at 48% per year for the last 5 years and growing even higher for the last 3 and 2 years.

 

** Zacks.com is currently estimating a whopping 48.58% sales growth for the next 5 years (which seems unreliable); First Call via Yahoo Finance is at 23.40% for this year and 12.20% for next; and Morningstar made no estimate as its analysts don’t cover AMED.

 

** Estimated sales growth is important on the SSG when it is part of the Preferred Procedure which Pat used to estimate EPS for the next 5 years.

 

– Pat’s PP began with 16.00% estimated sales growth. Because of anticipated cuts to Medicare which pays for some 87% of AMED’s patients, he used 12.00% PTPM, down from 13.1% actual for the last 5 years.  Pat doesn’t mention what he used for an estimated Tax Rate and Shares Outstanding, but his final result was 14.7% estimated EPS.

 

– I don’t use the PP as I think it involves too many estimates and way too much guesswork.  See my recent critique: Pondering the Preferred Procedure, March 28, 2009.

 

– So far, this has been conventional SSG methodology.  Pat’s unique method began next with establishing the Forecast Low Price for the next 5 years at $26.81 which, he judged, was about 20% less than AMED’s current price; dividing that by his Low EPS of $3.37 gave him a Forecast Low PE of 8.2; and he doubled that to get a 16.0 Forecast High PE because he thought that AMED’s historical High PE was roughly twice its Low PE.

 

– Pat’s method resulted in a 12.0 Upside/Downside Ratio and, as a general rule, I’m always wary of U/Ds greater than 10.0 as reflecting overly optimistic judgments. 

 

** The BI/NAIC SSG Handbook warns against abnormally high U/Ds, without suggesting any red-flag number, but does say that large Upside/Downsides are most often due to a Forecast Low Price that is too close to the stock’s current price.  See: BI/NAIC Stock Selection Handbook, pages 111-112 (2003 edition).

 

–  My only concern with Pat’s method is the special importance it places on the Forecast Low Price which, given our recessionary market, is extraordinarily problematic to estimate for the next 5 years.  Other than that, I hope he studies it with many companies and different industries, and lets us know what he finds.

 

 

Armin’s SSG:

 

– When I did my SSG, the six analysts I always check were estimating long-term EPS at an average of 19.90% with Zacks.com high at 21.43% and Value Line low at 16.50%.  S&P and FactSet CallStreet via CNNMoney were at 20.00%, FirstCall via Yahoo Finance was 20.23%, and Reuters.com was 21.25%.

 

** The consensus estimate at Reuters was from 8 analysts who ranged from 33.0% high to 15.0% low.  At CNNMoney, the 9 analysts ranged from 25.0% high to 11.0% low.  The lowest of all estimates was 11.00% and that was the basis for my EPS estimate.

 

– To determine my Forecast High and Low PEs, I used the TK5 software’s Alt-M command which averages the 5 lowest High and Low PEs in the last 10 years and is usually the most conservative of the four options I am offered.

 

** I most often use Alt-M when, as here, I know little or nothing about the company.

 

– My $82.70 Forecast High Price was squarely within Value Line’s $60-95 estimated High Price and, as a result, was neither too high nor too low.

 

– I used $17.60 as my Forecast Low Price (70% of the 52 week low price) and decided not to rely on the conventional but higher $23.40 (Low PE x Low EPS) even though I used Alt-M to produce a conservative Low PE.

 

** Unfortunately, I know of no guidance that suggests 60%, 70%, 80%, or whatever percent to use when we are dissatisfied with the conventional choices for estimating the Low Price for the next 5 years.  The SSG Handbook is silent in this regard and my choice of 70% is just a guess.

 

** AMED’s stock price fell -29% in the last 3 months, -27% in the last 6, and -18% in the last 12 according to Google Finance.  In the table above, it was currently trading slightly above its 52 week low.  This long-running price decline makes it unusually difficult to estimate AMED’s Low Price and when it will end is just a guess.

 

Take Stock:

 

 – Take Stock is a computerized one click program at the Stock Central website that produces an almost-SSG (no U/D, no RV/PRV), involves no judgment by the user, and is designed to produce a conservative result.

 

–  Here, TS’s algorithms did not work well as it produced the most optimistic result.  Its Forecast High Price was a whopping 44% greater than the high end of Value Line’s estimate largely because its Sales and EPS estimates were so high at 20.00% (the maximum that TS allows based solely on the stock’s history).

 

Conclusions:

 

– Whether you use the PP or not, whether you use conventional or unique methods, no matter what you use or how you do a SSG, it’s always helpful to compare your judgments and your results to some guidelines to see if you are out-of-whack or in the ballpark.

 

– I use comparisons all the time to help me determine what’s reasonable and what’s not.  See: Determining What’s Reasonable and What’s Not, July 14, 2008.

 

Armin

 

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Pondering the Preferred Procedure

  

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Conclusions:

 

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

 

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

 

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

 

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

 

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

 

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

 

Armin

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Studying Stryker (SYK), Part 2

 

In response to the first part of my Studying Stryker post, Michael Healy asked:  << Wondering if you have any insight you could share about how this [a Federal grand jury investigation] will affect what otherwise seems to be a great investment. >>

Last week, on the Better Investing Discussion List (old I-Club-List), Timothy Tsai asked a similar question: << Stryker is the target of a Fed probe. Is this something significant? or is it already factored into the price? >>

 

These questions may seem daunting, but they are not difficult to answer.  Here’s my approach:

 

Full disclosure: I like Stryker a lot, have no special knowledge or insight about its legal problems, and am much more scared about our recessionary market.

 

What I learned about the SYK investigation:

 

– A federal grand jury wants to know if Stryker Biotech, a subsidiary in Mass, illegally promoted and sold two, misbranded bone growth products, and submitted false reports to the FDA.

 

– This info came from a 3-10-09 Reuters.com news item and 3-11-09 S&P Stock Report.  It was almost word-for-word from SYK’s latest 8K report.  S&P added: << We view this news as a troubling expansion of existing investigation, raising corporate governance/oversight concerns. >> 

 

– S&P did not change its 4 star rating or Buy opinion on SYK, but did reduce its target price by $10 to $38 (with SYK selling at $32.12).

 

– Reuters also reported that former employees of Stryker Biotech have pled guilty to charges related to the investigation which began last year.  This was also in SYK’s 8K.  [Maybe the feds think: where there’s smoke, there may be fire?]

 

– Earlier federal probes were noted by S&P: 9-07, SYK agreed to federal oversight of consulting agreements with doctors for 18 months with no financial penalties; 10-07, SEC informal inquiry if SYK illegally sold products in certain foreign countries.

 

– SYK’s latest 10K annual report filed 2-20 with the SEC mentions these legal proceedings, but adds nothing more that I thought was noteworthy.

 

– Value Line has not issued any supplementary report about the investigation or downgraded SYK; Morningstar’s company report pre-dated the 3-10 news; and, although I don’t use them much, there are a bunch of other ratings to check in a week or so (if you’re still worried) to see what, if anything, has changed:

 

** CAPS rating by Motley Fool (5 stars with SYK at $33.81 on 3-13)

** StockScouter rating by MSN Money (9 out of 10 on 3-15)

** Yahoo Finance CGQ ratings (35.1% and 86% as of 3-1)

** Morningstar’s Stewardship Grade (C as of 1-28)

 

– Legal problems, especially lawsuits involving big bucks (like the class actions about cigarette smoking and Rx drugs), can cloud a stock’s price appreciation for an unknown amount of time.  While SYK may be fined, this federal investigation does not involve malfunctioning products or harm to patients.

 

– SYK is a medical device maker and will always be at high risk if and whenever its products don’t work.  Risk-adverse investors should avoid such segments of the stock market.

 

– Investors who do their own SSGs and research should have the confidence to investigate these issues on their own as they involve legal news, not legal questions.  I mean this as positive, encouraging advice.

 

– My sources were: Google Finance (got lots of news on the federal investigation); S&P, VL and Morningstar (free from my local libraries); and the company website (to check what legal stuff was mentioned in the latest 10K and 8K).

 

– Can anyone suggest other, readily available sources to check?

 

 

Armin [revised 3-17-09]

 

Boning-up on Buckle (BKE)

 

The Buckle (BKE) was this month’s Online Stock Study at the Better Investing website. 

 

Company Background:

 

BKE is a chain of 391 retail clothing stores that sells casual clothing to “trendy” young men and women who shop at malls.  Stores are located in 40 states, none of which are in the northeast, and 70% of sales in its FY 2007 were brand name goods. 

 

Like many retailers, Buckle had a tough year, but may be on the road to recovery: Google Finance reports that BKE’s share price fell 19% in the last 12 months and 38% in the last 6.  However, it fell only 2.6% in the last 3 and actually rose 3.5% last month after the company had a surprisingly good 4^th quarter and FY 2008.

 

The company reported that its Sales rose 21.5% in Q4 and 27.8% in FY 2008 which ended 1-31-09.  Comparable store sales increased 14.3% for the Q and 20.6% for the FY.  Nineteen new stores were added during the FY. 

 

The company has no debt and Value Line was favorable impreseed overall: << The Buckle has much going for it, including high margins and top-notch finances that allow for share buybacks and husky dividend increases. >> (2-6-09 VL report on BKE)

BKE’s  direct competitors, according to Hoovers.com and YahooFinance, are Abercrombie & Fitch (ANF), American Eagle Outfitters (AEO), and The Gap (GPS).

Buckle’s average Pre-Tax Profit Margin for the last 5 years is much better than its industry average (Apparel, Retail), but slightly below ANF’s and AEO’s.  Its Return on Equity for the same period is almost the same as its industry average, but much worse than ANF’s and AEO’s.

 

The BI Online Stock Study:

 

The March 2009 Online Stock Study was led by Diane Amendt, a member of the BI Volunteer Advisory Board, who did what she called a top-down study.  Diane picked BKE for this study after she first did a SSG to learn if the company warranted further research.

 

The Online Stock Study produces a Consensus SSG where the judgment calls are made by consensus voting.  The recorded session (about 1 hour), the SSG, Diane’s presentation slides, and the Value Line report on BKE are now available for downloading by BI members.

 

What follows is a comparison of the Consensus SSG with two SSGs of mine and with Take Stock.  My analysis and conclusions follow this table.

 

Buckle (BKE)	Consensus SSG	Armin-1	Armin-2	Take Stock
Date	2-20-09	2-21-09	3-8-09	2-20-09
Data	S&P	same	same	Hemscott
Price	$23.79	same	not changed	$23.79
52 week High & Low Price	$44.57 & $13.57	same	not changed	n/a
Project Growth From End of	Last Quarter	same	same	Last Annual
Sales Growth	10.00%	8.00%	same	5.90%
EPS Growth	15.00%	8.00%	10.00%	5.90% initial 1.89% final
High PE	15.0	17.8 (last 5 yr ave)	same	15.0
High EPS	$4.21	$2.38	$2.61	$1. 78
High Price	$63.20 ~$8.00/sh or 15% > VL	$42.40	$46.50	$26.76 ~$13/sh  or 33% < VL
Value Line Estimated High Price = $40-55 at $20.92 as of 2-6-09
Low PE	10.0	11.7 (last 5 yr ave)	same	8.4
Low EPS	$2.09 (ttm)	$2.09 (ttm)	same	$1.70
Low Price	$13.10 (ave low price last 5 years)	$16.70 (70% x curr price	same	$23.79 Yield Supported Low Price that overrode $14.28
Upside/Down	3.7	2.6	3.2	impossible to calculate
Total Return	24.7%	14.9%	17.0%	4.9%
SSG Buy Under	n/a	$23.09	$24.11	$14.94
RV/PRV (no outs)	77.6/67.3	77.6/71.7	same/70.4	n/a
Quality	n/a	B+	same	2.6
PTPM – 5 yr ave	15.8% trend up	same	same	15.8% trend n/a
ROE – 5 yr ave End Equity	16.1% trend up	same	same	n/a
ROE – 5 yr ave Start Equity	n/a	17.2% trend up	same	17.1% trend n/a
Debt to Equity – 5 yr ave	n/a	-0- trend even	same	n/a

 

The Consensus SSG:

 

– Diane used SSG software rather than the BI Online SSG which meant that she had the option to project future growth from the last quarter (which she did) and had more than one option for the Forecast Low Price (which she used).  The Online SSG does not offer those features.  Neither does Take Stock.

 

– The SSG involves making five estimates for the next 5 years, but I’m only going to discuss three of these Consensus judgment calls.

 

– Participants were givem four choices to estimate future EPS growth: 22.8%, the 5 year average EPS; 15.0%, Diane’s initial estimate (not explained); 10.0%, same as estimated Sales growth; and 17.0%, Diane’s maximum (not explained).  

 

** VL’s 15.5% EPS estimate was not considered, which I found surprising especially since VL’s Sales (actually Sales per share) estimate was considered when future Sales growth was voted on.

 

** The Consensus (52%) chose 15.0%, Diane’s initial estimate, while second place with 34% of the vote was for 10.0%, same as the Sales growth decision.

 

– To estimate the projected Average High PE, participants were given two, maybe three choices: 17.8, the 5 year average; 15.0, Diane’s initial estimate (not explained); and 15.0, the same as future EPS growth.

 

** The Alt-M option was not considered which averages the five lowest values in the last 10 years and is usually the most conservative option. Here, 15.6 was Alt-M’s average high PE.

 

** The Consensus (73%) chose 15.0, Diane’s initial estimate.

  

– The Forecast High Price is not a judgment call as it is simply the product of Projected High PE x High EPS which equaled $63.20.  I ALWAYS like to compare the Forecast High Price to VL’s estimate which was $40 to 55 in the next 3-5 years and meant that the Consensus was $8.00 per share or 15% greater than VL.

 

– For the last judgment call, Diane offered four choices to decide the Forecast Low Price: $20.90, the Low PE x Low EPS; $13.10, the average low price for the last 5 years; $13.60, the recent severe low price; and $6.90, the price BKE’s dividend will support.

 

** The Consensus (38%) chose $13.10, the average low price.

 

Armin’s SSG-1 and SSG-2

 

– When I did SSG-1 on 2-21, S&P had no Long-term EPS estimate and the five other analysts I always check were estimating an average of 11.50% with VL high at 15.50% and FirstCall via YahooFinance low at 8.38%.  Reuters.com consensus estimate was 10.70% (with 13.00% high and 5.00% low); FactSet CallStreet via CNNMoney was 11.00%; and Zacks.com was 11.14%.

 

** My 8.00% estimate was based on FirstCall, the lowest of the five estimates, as I thought that the 5.00% low estimate at Reuters was too low.

 

– I updated my SSG on 3-8 and found that S&P still had no EPS estimate while the average of the five other analysts had dropped slightly from 11.50% to 11.34%.  VL and FactSet were unchanged, FirstCall was 10.00% (up from 8.38%), Reuters was 10.50% (down slightly from 10.70%), and Zacks was 10.50% (down from 11.14%).

 

** I changed my EPS estimate to 10.00%, now the lowest estimate, just to see how that would affect my SSG’s outcome.  I did not change BKE’s price.

 

– It’s no surprise that my $42.40 Forecast High Price in SSG-1 and $46.50 in SSG-2 were well within the range of VL’s $40-55 estimated High Price.  If I substantially fall above or below VL’s estimate, I consider that a red-flag warning sign to revisit my judgments.

 

– I was surprised that SSG-2 satisfied the BUY Criteria, while SSG-1 did not, because all I changed was my EPS growth estimate from 8.00 to 10.00%.

 

– With SSG-1 and SSG-2, I used 70% of BKE’s current price ($16.70) as my Forecast Low Price because I didn’t like the standard choices offered by my SSG software.  The method most appropriate for growth companies (low PE x low EPS) was $24.50 and too high; the Average Low Price ($13.10) and the Recent Severe Low Price ($13.60) were too low.

 

** The Consensus chose the Average Low Price ($13.10) and was not offered the option I chose.

 

Take Stock

 

– Take Stock is a computerized program at the StockCentral.com website that produces an almost-SSG with one click that involves no judgment by the user.  It is programmed to produce a conservative analysis, ultra-conservative in my judgment, which is solely based on historical results.

 

– Take Stock initially estimated 5.90% EPS growth that was overridden by 1.89% from its so-called Business Model (another name for the NAIC/BI Preferred Procedure).

 

** The 1.89% final EPS estimate was way, way unreasonably low compared to the six analysts I checked for my SSGs.  The lowest analyst estimate was 8.00% on 2-21 and 10.00% on 3-8.

 

– Its no surprise that Take Stock’s $26.76 Forecast High Price was $13 per share or 33% BELOW VL’s estimated High Price of $40-55.  When you start with a low EPS estimate, for sure you will end up with a low High Price estimate.

 

– Take Stock’s Forecast Low Price is weirdly programmed: unlike the SSG, its Low Price is allowed to exceed the stock’s current price (a SSG NO-NO according to BI’s SSG Handbook).  Moreover, a special feature kicked in here where the Yield Supported Low Price of $23.79 was allowed to override $14.28 AND made it impossible to compare Upside-Downside Ratios. 

 

Conclusions:

 

– The 15% EPS growth selected by the Consensus SSG was much higher than what the analysts were estimating.  By starting high, its resulting Forecast High Price was 15% higher than VL’s estimate.

 

** To learn whether our EPS estimates are out-of-line or whacky, too high or too low, I have explained my approach at: Estimating EPS

 

– Small changes on the SSG can have a big effect.  My SSG-1 did not satisfy the Buy Criteria while my SSG-2 did and the only change I made was to increase EPS growth from 8% to 10%.

 

** When I come close to satisfying the Buy Criteria (a 3.0 Upside-Downside Ratio and the 15.0% Total Return), I’m going to complete different “what-if” SSGs to learn what happens when I change 1 or 2 key judgments.  Our SSG software makes this easy to do.

 

– Armin

 

** Please help me improve this SSG Blog by leaving a comment and/or taking this short & easy poll:

 

 

 

Estimating EPS

UPDATED JANUARY 18, 2011

This post supercedes Estimating EPS (March 5, 2009) as BetterInvesting changed its provider of SSG data from S&P to Morningstar on December 22, 2010.  And, the Morningstar data also comes with a long-term EPS estimate from Zacks in place of the previous estimate from S&P.

In addition to making those revisions here, I also took the opportunity to add new material as well as to check and recheck the accuracy of everything else.  Because many of my other posts link to this one, I decided not to change its URL/web address and put all the new stuff  in blue.

By far, the most important judgment on the SSG is our estimate of the company’s EPS growth rate for the next five years.  This estimated rate directly determines the High and Low EPS in dollars which are then used (in part) to determine the Forecast High and Low Prices.  No other SSG judgment has such a major impact on the final result.

 

Our estimate of future Sales growth is only used as part of the Better Investing/NAIC Preferred Procedure which is one method for estimating EPS.  I use another method and here’s how I estimate EPS for all my SSGs:

 

(1) I ALWAYS check seven long-term EPS estimates for every SSG I do, from:

 

– FactSet CallStreet via CNNMoney.com

– FactSet via Reuters.com

– Thomson FN via YahooFinance.com

– Thomson Reuters via Reuters.com

– Zacks.com

– Zacks via BI.org [the only one I pay for which also comes with SSG data from Morningstar] [added 1-18-11]

– Value Line (from my library)

 

(2) The first five are free and easy to get from the Research Links page at StockCentral.com.  Once there, just type in a ticker symbol and click the estimate link which will take you directly to the correct page at that website.

 

– The Stock Central Reasearch Links page is free and you will find a link to it on My Favorite Links page; click here.

 

(3) These are all long-term EPS estimates.  Reuters doesn’t say how long, VL is for 3-5 years, and the remaining five are for the next 5 years.

 

If anyone knows of other free estimates from different data sources (not simply different web sites), please let me know.

– There’s some dispute about the meaning of VL’s 3-5 year period.  Manifest Investing, a subscription site that uses the SSG, thinks it means 4 years and then extrapolates another year as our SSGs want a 5 year estimate.  I disagree and think VL’s estimate is for a 3 and 4 and 5 year period. [added 3-17-11]

 

(4) Note that these are seven different estimates, not just from seven different websites.  It’s not always easy to tell, but I believe the following is accurate [revised 1-18-11]:

 

– Thomson Reuters (old Thomson/First Call and Thomson FN still to some) provides EPS estimates to YahooFinance, Reuters.com, CNBC, and AOL’s Daily Finance;

 

– Zacks Investment Research furnishes EPS estimates to MSNMoneyCentral, NASDAQ.com, SmartMoney.com, StockSelector.com, ClearStation.com, and Zacks.com.

 

Thus, it’s not very helpful to check several websites when the EPS estimate is provided by the same source, say from MSN Money and SmartMoney since Zacks provides both estimates.  On the other hand, it is very helpful to check different data sources (not just different websites) for their EPS estimates in order to learn which is high, low and wacky.

 

(5) I evaluated the different estimates before BI switched from S&P to Morningstar and compared the 7 estimates for 6 companies over 7 quarters together with EPS estimates from Take Stock [added 1-18-11]: 

 

– All the estimates are tabulated and my findings set forth at: Evaluating EPS Estimates, click here.

** I confirmed that all seven of these estimates are still different;

 

** I found that Value Line’s estimates were often at the far end (either low or high) of the seven; and

 

** I did not include Take Stock in the averages I calculated because, compared to the seven mainstream estimates, it was repeatedly irrational and outrageously untrustworthy.  

 

(6) Seperately, I learned that Zacks.com EPS estimates are also different from the Zacks EPS estimates that now come with SSG data from BI. To make sure, I checked 25 different stocks in 7 different industries and the two estimates were always different. [added 1-18-11]

  

(7) Only one of the seven estimates, from Reuters.com, provides more info than the other estimates which only provide the consensus estimate.  In addition to the consensus estimate, Reuters also provides the number of contributing analysts and the high and low estimate. 

 

– The extra info provides helpful context and I put less weight on estimates that are made by only a few analysts.  The high and low estimates are also useful to indicate whether those analysts are in close agreement or far apart. [revised 1-18-11]

 

(8) StockCentral.com, like BetterInvesting.org, also provides the same SSG data from Morningstar that also includes an EPS estimate from Zacks.  Previously, StockCentral’s SSG data did not include any EPS estimate. [revised 1-18-11]

– Both StockCentral and BetterInvesting are subscription sites, and you can find a link to them, their rates, and free trials on my “Favorite Links” page; click here.

 

(9) We don’t know the names of the analysts that make these EPS estimates and therefore can’t determine the extent of overlap among the seven that I routinely check.  However, we DO know that the these estimates are far from identical.  Consider these current examples [added 1-18-11]:

– Value Line’s long-term EPS estimate for Baidu (BIDU), a high-flying Chinese Internet search engine, was 44.00% on 1-13-11, FactSet CallStreet via CNN Money was 50.00%, Thomson FN via YahooFinance was 54.63%, Thomson Reuters via Reuters.com was 56.17%, FactSet via Morningstar.com was 56.80%, and Zacks.com was 59.19% while Zacks via BI was 70.50%. 

** Here, VL was the lowest, Zacks via BI the highest, and the difference was a whopping 26.50 percentage points [hereafter: pp].  Moreover, the difference between just the two Zacks estimates was a surprising 11.30 pp.  And, if VL was eliminated as an atypical outlier, the spread between the highest and lowest was still a substantial 9.19 pp;

– Cardinal Health (CAH) is another example where VL was again low at 8.50%, FactSetCallStreet via CNNMoney was high at 14.00%, and the spread between highest and lowest was 5.50 pp.  Moreover, the difference between the two Zacks estimates was just over 3.00 pp; 

– Intel (INTC) is a third example where VL was high this time at 17.50%, Zacks.com was low at 9.14%, and the spread was a hefty 8.36 pp. 

** Without VL, the spread between the highest and lowest was 2.70 pp and the difference between the two Zacks estimates was 1.86 pp.

(10) After collecting all seven estimates, there are several ways to utilize the data:  

–  Excel can easily calculate the average and the average less one Standard Deviation.  That, in my judgment, results in a reasonably conservative estimate and adequately “wrings-out” over-optimism.  If you want to be tougher, you could reduce the average by two Standard Deviations although I think that is usually too tough as this is not rocket science;

– Also, any odd-ball estimate could be treated as an outlier and eliminated from the average.  And, the lowest estimate of the five (or six) could turn out to be more reasonable than the average less one (or two) SDs;

– You could also compare the average and the lowest estimate to your own EPS estimate, especially one from BI/NAIC’s Preferred Procedure which involves making four other estimates for the next 5 years: Sales growth, Pre-Tax Profit Margin, Tax Rate, and Shares Outstanding.  I stopped using the PP because, for me, it involves too many uninformed estimates and too much guesswork.  See:

Determining What’s Reasonable and What’s Not: An Update (probing the PP of CTSH)

Pondering the Preferred Procedure (peering at the PP of ORCL)

(11) There are several reasons why I check all seven EPS estimates:

– I learn which are out-of-whack and which are in the ball park;

– I learn what is conservative and what is optimistic; and

 

– I have some rational basis for what seems reasonable and what’s not.

 

Moreover, when I do my SSGs, I do not have to rely on my gut feelings or some ambiguous sense of sleeping well.  I sleep better knowing that I have tried to be reasonable by doing my homework.
 

Armin

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