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Appendix 1 On-line Resources http://www.better-investing.org/ The Better Investing (NAIC) Web Site http://www.better-investing.org/ The Better Investing (NAIC) Web Site http://www.investorwords.com/ A glossary of financial terms http://www.valueline.com The Value Line home page http://www.manifestinvesting.com/ Site that applies BetterInvesting principles in a unique and effective manner http://www.buyandhold.com/ Site for low cost investing; not Buy and Hold has been purchased http://www.zecco.com/ A deep discount broker, actually $0 commissions
Appendix 2 Completed SSG for Clayton Homes Please note that after this work was published, Clayton Homes was bought in its entirety by Warren Buffett. While no investment advice is given or should be inferred from Dollars from Sense, you should be aware that it is no longer possible to buy Clayton Homes directly. To own the company, you now have to spend tens of thousands of dollars to purchase one share of Berkshire Hathaway. Appendix 3 The Value Line Investment Survey What exactly is Value Line? Let’s start by answering this question. As you know, public companies are required to (1) file information with the SEC and (2) provide financial information to shareholders and other interested parties. Annual reports, which contain this information, come in all shapes and sizes. Different industries have different methods of accounting. Value Line standardizes all these disparate means of reporting into a simple, single-sheet, format. Value Line condenses ten years of information, provides company information, gives a subjective opinion on the company operations and compares each company with every other company in the survey. In a nutshell, Value Line is a treasure trove of information! A copy of the Value Line investment survey for Clayton Homes is found above. I know, it’s small and hard to read! However, the main areas are shown. There’s a copy of this Value Line survey in Chapter II. In addition, there should be a copy at the end of this publication. This diagram is meant to show the main areas of the survey, I’ll refer back to it often. The previous diagram shows the “geography” of the report. Again, I know the print is small. You’ll find a completed SSG at the end of this appendix. This small diagram is provided solely to show the lay-out or geography of a typical report. All Value Line reports follow this format. Running through the Value Line
The company name, exchange, and the ticker symbol are all found on the top left-hand side of the survey. Moving across the top, the next number is the recent trading price for shares of the company. The price is about two weeks old by the time the Value Line arrives. If you want to find out the delivery date, look to the bottom right of the section I call “recent information and analyst’s comments.”
Right after the price, PE ratios are provided. The PE ratio will be described in detail in Chapter III. In summary, you find the PE by taking a stock price and dividing it by the annual earnings per share (EPS) of a company. Value Line has an interesting way of determining the PE. It takes earnings for a year—actually earnings for four quarters—but finds those earnings a little bit differently than you might expect. The analyst looks at the past two quarters of reported earnings and then adds in projected earnings for the next two quarters. Four quarters of earnings added together gives a year of earnings. This number is divided into a recent share price to give a PE ratio. In Value Line, projected numbers—estimates of the future—are always printed in a bold italicized font. Two PE ratios are provided in parentheses. The first is a “trailing PE” ratio. The trailing PE is the classic PE that many people are used to. It takes the past four reported quarters of earnings, sums them up, then divides this number into a stock price to give the PE ratio. The median PE ratio is even more interesting. The PE ratios (trailing) for the past ten years are written down and ordered from highest to lowest. The top and bottom three are discarded, leaving four in the middle. The average of these four is then reported as the median PE. The median PE gives an indication of the historical average PE.. You’re probably PE’d to death right about now, but there is one more Value Line PE to go. Value Line calculates a relative PE ratio by dividing the average of the median PE ratios for all of the 1700 stocks under review into the PE for the company of interest. A number less than one indicates that the company has a lower PE ratio than the ‘average’ PE of all 1700 companies; if it’s greater than one it has a higher PE. Finally, Value Line reports the dividend yield for the company. A dividend is a cash payment that the company pays to shareholders of record. This payment is authorized by the board of directors. Not all companies pay dividends. Often, new companies in a growth industry don’t pay dividends; mature companies often do. As we will see later, Value Line lists dividends for the past ten years. Just because a company pays a dividend doesn’t obligate it to pay one in the future; however, most company managers know that once paid, shareholders expect payment to continue. They also expect that the dividend will never decrease! The dividend yield is the dividend divided by the share price. A dividend yield of 2% means that you should expect 2% back on everything that you invest (assuming that the dividend stays constant.) Remember: the dividend is just one component of the return you might expect—the share price can increase in value too. Safety and Timeliness Moving back to the left-hand side, you’ll see a box something like the one on the left. Value Line takes the 1700 in the survey and ranks them from highest to lowest in terms of timeliness, safety and technical. For the timeliness ranking, the top 100 receives a rank of 1. The next 400 gets a rank of 2, the next 700 are ranked 3, the next 400 earn a 4 and the bottom 100 merit a 5. In this example, Clayton Homes has received a three for timeliness, safety and technical. It’s right in the middle of the 1,700 companies in the survey. For the safety indicator, the numbers in each ranking are not fixed. These rankings are interesting and informative. The first point is that the time horizon for the rankings is twelve months. In 1993/4 many health care companies scored low in timeliness and safety. These rankings were warranted. While the 12 month outlook was dismal, the five-year outlook was quite promising. Timeliness refers to the expectation for capital appreciation (stock price growth) over the next 12 months: the chance the price will go up! Companies ranked 1 are most likely to go up in price, those ranked 5 are least likely. Value line has a proprietary method for ranking companies based on a combination of the past trend in earnings and stock price. The ranking also includes price momentum—how fast the price rises—and if the company has earnings surprises. An earnings surprise happens when a company reports EPS numbers that are higher than expected. When such a surprise occurs, the stock tends to appreciate in price. The Value Line safety ranking is a measure of volatility. The safe ranking includes measure of the price volatility of the stock in comparison to other stocks in the survey. The ranking also includes the financial strength rating of the company in question. Both these measures are found on the bottom right-hand side of the report. In developing a ranking for safety, they are weighted equally. The technical measure is seldom of any concern to NAIC-style investors. This indicator uses a formula—known to Value Line alone—to rank stocks on the likelihood that they will have a price appreciation in three to six months! The measure is based on an analysis of price tends in ten recent periods. Value Line publications caution that this indicator is secondary to both timeliness and safety. One final statistic that is provided is “beta,” pronounced BAY-ta. Beta is a measure of volatility compared to the market. When Value Line derives a beta for a stock, the reference is the New York Stock Exchange Composite Index. A beta of one means that the stock under consideration moves with the market. A beta of 1.1 suggests that if the market appreciates 5% in value the stock will gain more than the market. If the market falls 5%, the stock will drop by a greater percentage than the overall market. The higher the beta is above 1, the move volatile the stock is. Conversely, if the beta is lower than one, it suggests that when the market appreciates the stock does not move as aggressively. If the market tanks, the stock falls, but not to the same extent as the market. Beta is calculated from historical information and derives from a model called the Capital Asset Pricing Model or CAP-em! Volatile stocks have a high beta. Value Line Projections The next box is future projections. Using a model not dissimilar to the SSG, the analyst tries to determine a stock price range, in this case, for 2003-2004. The projected price range gives a high of 30 and a low of 20. If the high is reached it implies an annual rate of return of 35%, while the low projected price implies a growth of 23% per year. Since we are interested in doubling our investment in five years, both the high and low growth rates exceed or goal of 15% per year. Insider Decisions Insider decisions follow the projections box. Here information is reported for the preceding nine months. The table lists the number of insiders (officers of the company, etc.) who bought, sold or exercised stock options. In August, September and October of 1999, two insiders bought stock. Peter Lynch is of the opinion that when a stock price is deflated insider buying is a very bullish (positive) sign. He does not have an opinion on selling. Institutional Decisions The final box lists Institutional Decisions.. Institutions consist of pension funds, mutual funds, companies that manage over $100 million. They make their activities public. The information in this box lists the shares bought, sold and held in each of the past three quarters. The numbers are reported in thousands. For example, in the second quarter of 1999, 78,000 shares were bought and 65,000 shares were sold by institutions. Low institutional ownership is often viewed as a positive thing. I showed earlier a rudimentary model that many institutions use. This model can trigger a price drop if the company misses an earnings target by a small amount. If there are few institutional owners, this kind of volatility would not be expected. For a long-term investor, however, I believe volatility is a good thing. If institutions take a narrow view of the long term prospects of a good company, and bid the price down when there is a minor shortfall in earnings, I celebrate. For those of us who buy regularly, it’s good when the price drops. I like it when bad things happen to good companies! Let others panic while I profit. J Capital Structure Below the description of the company lies the capital structure box. Here you find out how the company pays for its assets. We’ve talked about this already. The assets equal the liabilities plus the equity. The assets are either funded by (i) borrowing money or (ii) selling part of the company. This section tells you how the company did it. The capital structure is given at a point in time. For the example of Clayton Homes, the capital structure on December 31, 1999 is given. The first area at the top breaks down the debt. The total debt is just under $100 million ($96.9). I look at total debt, then scoot over to net profit to compare one with the other. Looks like Clayton Homes has a net profit ($155 million) greater than the total debt. The company has long term interest of $5.2 million on long-term debit of $94.8 million—a quick calculation gives an interest rate of around 5% (interest payment divided by debt). The 9% in parentheses is the percentage of the total capitalization in the form of debt—it’s quite a low number. If there are any other outstanding “loans” or indebtedness—like a pension obligation or preferred stock—these are detailed next. Finally, the total number of shares outstanding is provided. This number is at least as current as that in the statistical table—sometimes it’s more current. Clayton Homes finances 9% of its assets through borrowing (debt) and 91% via equity. The last number in this section is market capitalization—described earlier. The market capitalization, market cap, of a company is determined by taking the number of shares outstanding and multiplying it by the current share price. When this calculation was performed, the market capitalization for Clayton Homes was determined to be $1.3 billion. In other words, the market puts a total value on Clayton Homes of $1.3 billion. Current Position The next box provides highlights from the balance sheet for the past three years. Information on current assets and liabilities is provided. Subtracting current assets from current liabilities gives a thing called “working capital” or “net current assets.” Working capital is a measure of the ability of a company to meet day-to-day (current) obligations. The working capital for Clayton Homes is reasonably stable; seven to eight hundred million dollars. In this industry, the working capital is quite a large percentage of total revenues. Annual Rates The annual rates section is one that I focus on immediately. The Value Line analyst provides information on annual growth rates for revenues, cash flow, earnings, dividends and book value. Historical and projected information are provided: growth rates for the past ten and five years together with estimates for the next five. You can review the historical information and determine if (a) growth rates are sustained over time, (b) growth rates are consistent for sales vs. EPS, (c) do growth rates suggest that the investment would be acceptable, (d) are projected growth rates acceptable. First off, look at the ten and five year growth rates. If the five-year number is lower, then the rate of growth is slowing down. If it’s higher, the growth is accelerating. If EPS have consistently grown faster than revenues, be prepared for a slowdown. Earnings come from revenues. Earnings are the difference between revenues and expenses, so to have fast earnings growth, expenses must be reduced. There is a limit to how much can be whittled away from expenses. Ultimately, these two growth rates converge. If earnings are growing consistently more slowly than sales, that could be a problem too. The cost structure of the company is expanding. When reading the numbers, is the rate of growth between 14-15% annually? That’s the kind of growth rate we need to double an investment in five years. Are the projected growth rates greater than about 12%? If they’re in single digits, I might start to get concerned. The SSG must be completed before an informed decision can be made. Even though growth rates might be low, the stock price could be sufficiently depressed that there is still a possibility for the investment to double in five years. Perhaps dividends can makeup the shortfall in growth. All these factors will become apparent when the SSG is completed. However, I am always nervous about slow growing companies. I want a company to be in its growth phase, not approaching the decline phase (see the section on the Business Life Cycle). Quarterly Revenues, Earnings and Dividends The final entries on the left hand column provide quarterly information. Information on revenues, EPS and dividends is provided for twenty quarters in all: the past thirteen to sixteen quarters and projections for the next four to seven. The results for the fiscal year are tabulated on the right hand side of each table. These numbers also appear in the statistic section of the report. Scanning the quarterly information can show the cyclical nature of a business. For example, Clayton Homes usually has an earnings jump of 50% in the last quarter of a fiscal year (each June); this jump results from a leap in revenues of about 33%. This difference in increase is not critical. Sometimes a company has a high fixed cost; an expense they incur regardless of the level of revenues. Once they get over this hurdle, earnings can grow faster than sales. The following comment on dividends should be made. Dividends are the only uncontaminated number reported by the company! While the accrual principle gives accountants leeway in other areas, a dividend is cash—you either receive it or you don’t. In that regard, companies are normally very careful not to tinker with their dividend policy. As stated previously, if the dividend is cut, look for a very good explanation as to why! Value Line Graph The graph contains ten years of historical information plus projections for the next five years. During recessions the graph is given a shade of gray. If you look over to the left for 1990, the graph is shaded. The graph for Clayton Homes above will be used as an example. The horizontal line represents the year. For example, the first year of information is 1990—you’ll find it on the very bottom, towards the left-hand side. The banner across the top of the graph contains the high and low stock price for each year. The high/low prices are to the left of the letter A in the graph above. The high and low prices are for the calendar year—not the company fiscal year. On the left-hand side of the graph, letter B, you’ll find the legend. This legend lists dates and quantity of recent stock splits as well as the cash flow multiple—discussed in a moment. If you look at the bottom of the graph you see a series of vertical lines, to the left of the letter C. The line represents the percentage of outstanding shares traded each month. The scale for volume traded is on the left-hand side.
The graph is log-normal, just like the SSG. In other words, on this graph paper, if something is plotted that increases at a constant rate, it will give a straight line. There are three things plotted on the graph: stock price high and low for a given month, a dotted line for relative price strength, and a solid line—the Value Line! The stock high and low is pretty self-explanatory. The price scale is on the far right-hand side of the graph. The dotted line, relative price strength, is a summary of the price behavior compared to the 1,700 stocks in the survey. If the line is level, this company is performing as average. If the line climbs, the company is performing better; if the line falls, then most other companies in the survey have better stock price performance that the one currently under study. The Value Line is actually a measure of cash flow. It contains EPS with depreciation per share added back in. The resulting number is multiplied by some factor. Value Line believes that stock prices tend to move close to this adjusted cash flow line. Finally on the far right hand side of the graph are projections for the stock price. These are calculated using a proprietary method. The projections were provided elsewhere in the report. You can use this projection to compare your view of the company with that of the analyst. Business Summary Value Line includes a short summary of the company. The business section for Clayton Homes is provided below.
The section gives a description of the business together with contact information for the Investor Relations department, the web site, and insider holdings. Below this section is a 400-word report on recent news. This report is reviewed and issued every three months. The report contains the opinion of the Value Line analyst who follows the company. Table of Financial Information Finally, the statistical array section gives a wealth of financial information on the company. I will go through most of these in detail below. This array can be industry specific. For example, the layout is very different for financial services companies (banks, brokers, insurance and so on.)
The statistical array is divided into two zones. The banner across the top contains the years and each column below lists information for that year. The legend for each line is found over on the right hand side. Historical information is written in a regular font, analysts projections are written in a bold, italicized font. The top zone of the statistical array contains per share data and some stock statistics (PE ratios). A thick line has revenue information right below it. There is no per share information in this subsection.
When a stock split occurs, all relevant numbers in the statistical array are adjusted to reflect this change. In addition, and this is an important point, many items on the Value Line report are normalized. The Value Line analyst makes a very critical review of the numbers reported by the company. The analyst is interested in the operations of the company. So, if the company reports a component of earnings or sales that is somewhat unusual or could only occur once, the analyst might ignore that contribution. For example, if a company was given a one-time tax break by a foreign company, significant enough to contribute 2¢ per share to earnings, the analyst might subtract off these two pennies. They’re not likely to occur again. Whenever such adjustments occur, the are described in the footnotes at the end of the report. The first line provides revenues per share. This line should move with the EPS (earnings per share line). Sometimes, if revenues accelerate sharply a company, with a lot of fixed expenses, can have earnings move up faster than revenues. If earnings per share are dropping due to a decrease in sales, take a look at the pretax profit margin. If this too is shrinking, it probably means that there is strong competition from a new source. You can review the “letter to the shareholders” section in the annual report for information. Alternatively, call the company directly and ask the investor relations representative to send you a “recent analysts report.” These reports contain a wealth of information and opinion. Cash flow per share is listed next. Cash flow reported by Value Line is earnings with depreciation per share (a noncash item) added back in. If the company issues preferred dividends the sum of these dividends is divided by the number of common shares outstanding. The resulting number—now per share information—is subtracted from EPS. As described earlier, cash flow shows the ability of the business to fund growth. Stronger is better; however, the ideal company will have consistent cash flow that tracks earnings. Earnings per share is next. EPS has been defined elsewhere. Earnings are normalized, if appropriate. Value Line reports diluted EPS. Remember companies report basic and diluted. Diluted earnings appeared in 1997. Value Line reports diluted for years after 1997. If a company goes back and recalculates past earnings, Value Line might include these. The next line is usually dividends per share—cash payments to shareholders. Not all companies pay dividends—most do not. Generally, young growth companies retain all earnings to fuel continued growth. Mature companies in established industries pay a considerable portion of their earnings in the form of dividends. The ten years of information are useful. Strong companies generally have stable or increasing dividends—they seldom reduce their dividend. In fact, with a few exceptions, when a company decreases its dividend, it means trouble. If you notice that the company you’re about to analyze cut its dividend recently, take it as a big, red flag. Next follows capital spending per share. Capital spending is a harbinger for the future. All else being equal, if a company can have superior growth to competitors with a smaller percent of earnings used in capital spending, then it’s a better managed company. Capital spending is needed to support top line growth. If you see declining capital spending, it could be a warning sign. Book value per share is what the shareholder owns. Keep in mind that accounting principles distort book value (the historical principle, expensing R&D, and so on). The BVS is seldom an accurate measure of the value of the shareholders capital. Book value almost always underestimates the true worth of the net assets. The next line contains the average number of shares outstanding. These are listed in millions for most companies—billions for large companies. This number—in fact all numbers—is adjusted, retrospectively, for stock splits. You can skim across this line to see if the number of shares is stable. If it increases, it could mean that the company used the cash generated to pay off debt, fund growth or make an acquisition. If the company issues additional shares, EPS might stagnate or drop even if sales and net income are increasing. Recently, many companies buy back their own shares, causing the number of shares outstanding to drop. When this happens EPS rises. The next two lines contain PE ratios ; the first is the average annual PE, the second is the relative PE for each of the past ten years. Here you can see if the PE is expanding or contracting. Remember that the relative PE is the company PE divided by the average PE for the entire Value Line survey. The next line is the average annual dividend yield (see chapter 3). High yields suggest a mature company. The analyst also provides projected yields. Dividend yields of less than 2% generally don’t have a major impact on overall appreciation in the short run. Now we have numbers taken from company sources (10-K or the annual report. This information may be normalized if the analyst determines that the source of the activity is not fundamental to the operations of the company. The first line is (in non-financial services companies) revenues. Revenues grow steadily for a growth company. By skimming across this line, you can determine if revenues increase consecutively from year to year. Revenues are the top line of the income statement and in a sense tells you how the company interacts with its external environment—the market it serves. Revenues are also used as a gauge to the size of the company. Market capitalization is subject to the vagaries of the stock market. Looking at a company’s revenues gives a better insight to the true size of the company. The line following revenues is operating margin. The operating margin is the income before interest and taxes. One good point about looking at EBIT is that to some extent you ignore capital structure. For example, if you had two companies, one of which had debt to total capitalization of 90%, while the other had only 10%, you’re ignoring the interest payments of highly leveraged company. You can see which option—financing with debt of equity—produces better results. In a given industry, the company with the largest sustained operating margin is often the leader. This company has learned to do more with less. It has imbued its employees with a cost cutting, no nonsense attitude. Consistency is the key in EBIT. EBIT is followed by depreciation. Remember that depreciation measures consumption of a tangible asset—amortization measures consumption (using up) of an intangible asset (patents, good will and so on). You expect higher depreciation for capital intensive industries—that is, those industries that require a lot of hard assets. If depreciation expense tracks reasonably well with sales, it suggests that the company is investing sufficiently to maintain future growth. If you notice depreciation falling, you might want to investigate further. For example, if an airline had steady sales growth but falling depreciation, the company may no longer buy aircraft outright, but rather lease them. While the lease expense might be the same as or similar too the depreciation expense, it shows up in a different part of the income statement. Leasing expense indicates that company has forked over cash—depreciation (and for that matter amortization) are non-cash expenses. By the way, the depreciation expense itemized here is for financial reporting purposes—not tax reporting. As reported elsewhere, depreciation schedules for tax and financial reporting purposes differ. Net profit has been discussed previously. It’s the number from which an earnings per share statistic is derived. If the number of shares outstanding is increased EPS can fall. If this situation occurs, you can examine net profit to see if it is increasing steadily. This situation might occur for newer companies. Generally, you want the net profit to increase steadily from year to year and to track sales. Let me skip taxes for a moment. (I wish!) How net profit tracks revenues can be determined from the net profit margin. The net profit margin is obtained by dividing the net profit by revenues. Ideally, this margin should be steady or increasing slightly. The net profit margin should also track EBIT (operating margin). If these two margins diverge, chances are there is either an increase in interest or taxes. (If interest increases, the company has probably borrowed more. You’ll likely see a spike in ROE.) You can also skim the like just above—the tax rate—to see if anything there could impact the divergence. EBIT is before taxes are paid, while the net profit margin has had taxes subtracted out. The tax rate is given between net profit and the net profit margin. Taxes more often than not remain pretty steady. However, if the company loses money (not my kind of company) in any year, it doesn’t pay taxes. The loss can carry forward against future earnings, which lowers the tax burden for successive years. Companies with a large capital base—a lot of tangible assets—can have a bouncy tax rate too. This effect is due to the impact of depreciation schedules. When a new asset is installed, the taxes on a steady income stream can be low the first few years. If the company has significant operations overseas, the tax rate can be impacted. Tax schedules overseas can be very different compared to the US. Since financial statements are consolidated, they include taxes from all sources. Working capital was discussed earlier when we reviewed the “Current Position” section. Working capital is current assets minus current liabilities. Liabilities are current if they are due within 12 months. Assets are current if they will be converted to cash within a year. Working capital is also called net assets. Working capital should track sales. As revenues increase, a greater amount of working capital is required to support and finance them. Computers should impact working capital! Nowadays, many companies have sophisticated computer networks that track one of the major components of working capital: inventories. Since companies can now model demand and manage inventories more effectively, there is a move in some quarters towards Just In Time (JIT) inventories. If companies can lower their requirements for inventories, working capital also decreases. Companies don’t need to do short-term borrowing to finance working capital, so interest expense declines. Overall, earnings increase. Working capital should track sales. The leading company in the industry often has a lower that average rate of working capital to sales. Some industries (for example, the airline) have companies with a negative working capital. Long term debt follows working capital. Long term debt can spike when a company makes an acquisition. Stronger companies can pay down debt faster than weaker. If debt is trending up, it should track depreciation and sales. It is difficult to justify adding long-term debt without observing a concomitant increase in sales and earnings. Adding debt will boost the return on equity—at least for the short term—since increase interest expense will affect earnings. The shareholders equity is equivalent to net worth. Shareholders equity per share differs from book value per share, since book value subtracts payments due to preferred shareholders. Shareholders equity includes all stockholders: common and preferred. Shareholders equity should, ideally, track both revenues and net income. Shareholders equity is the driver of the company! Return on total capital measures the return on long-term debt plus shareholders equity. As equity increases so too should earnings. If the company elects to pay down debt (reduce long-term debt), equity as a percentage of total capitalization will increase. As a result, if return on total capital increases, it’s probably due to an increase in earnings, perhaps as a result of decrease interest payments on the lower debt load. The return on total capital should track the next item—return on common equity. Return on shareholders equity is the return on the part of the company that the shareholders—common and preferred—own. Unlike the return on total capital, the return on shareholders equity does not include long term debt. If a company (such as Clayton Homes) has not issued or has retired preferred shares, the this statistic should mimic the ROE, discusses in Chapter 2. Return to shareholders equity and total capital should track. If they don’t, examine the changes in the level of long-term debt.
Index 1 10-K, 27, 33, 69, 205 10-Q, 27, 33 4 401(k), 4 403(b), 4 A Abbott Labs, 66 accounts payable, 36, 44 accounts receivable, 44 accrual principle, 30, 42, 200 acquisition, 72 additional paid-in capital, 37, 47 AFLAC, 161 all or none, 16 allowance for doubtful accounts, 31, 39, 44 American Stock Exchange, 21 AMEX. See American Stock Exchange Amgen, 162 amortization, 29, 34, 206 analysts report, 204 annual rate, 68, 199 annual report, 27, 33, 193, 205 AON. See all or none Appendix 1, 187 Appendix 2, 189 Appendix 3, 193 AquaPharm, 101 area method, 66 ask price, 17 asset, 34, 96 current, 207 authorized shares, 11 B Balance Sheet, 34 best fit method, 67 beta, 196 Better Investing Magazine, 6, 26 better-investing.org, 6 bid price, 17 big board, 12 bigcharts.com, 23 board of directors, 8, 11, 23, 41, 103, 132 Boeing, 66 bonds, 9 convertible, 9 zero coupon, 9 book value, 90, 199 per share, 90, 205, 208 bottom line, 40. See net income broker, 11, 14, 15 business cycle, 93, 122 business life cycle, 19 Business Week, 26, 31 BVS. See book value per share C calculating growth rate, 68 pretax profit margin, 86 callable bonds, 9 capital, 7, 8, 37, 91 defined, 47 Capital Asset Pricing Model, 51, 196 capital intensive, 206 capital spending per share, 204 capital stock, 8 capitalization, 60 cash flow, 202 from financing activities, 45 from investing, 45 from operations, 42 per share, 204 CEO, 8 certificate, 7, 8, 16 CFO, 8 Champion Enterprises, 141 charter, 7 Choose from among growing companies, 5 Clayton Homes, 39, 86, 88, 91 balance sheet, 35 completed SSG, 189 EBIT, 40 income statement, 38 Portfolio Management Guide, 152 preferred procedure, 93 preferred shares, 36 shares outstanding, 41 Statement of Cash Flows, 42 Statement of Shareholders Equity, 46 teaching example, 59 Value Line. See Value Line report, 60, 61 CNBC, 26, 27, 34 CNNFn, 27 common stock, 47 compound interest rate, 135 compounding, 134 comprehensive income, 47 CompuFest, 6 Congress. See National Congress conservative principle, 31 consolidated financial statements, 207 consolidated statement of income. See income statement consolidation, 72 Continental Airlines, 32, 141 convertible bonds, 9 corporate charter, 7 corporate tax, 88 corporation, 6 cost of goods sold, 39 cumulative earnings, 156 CureAll Hydrochloride, 101 cyclical company, 122 D day only, 15 debt long term, 207 deferred income tax, 89 depreciation, 28, 32, 88, 206 depression, 19 diluted EPS, 41 dilution, 9 disclaimer (please read), 59 discount rate, 49 distribution to owners, 48 Diversify to reduce (optimize) your risk, 5 dividend, 4, 22, 48, 103, 172, 204 policy, 139 price supported by, 123 vs. accrual principle, 200 yield, 23, 85, 108, 123, 131, 172, 205 dividends, 146 DJIA. See Dow Jones Industrial Average dollar cost averaging, 139
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, 2 Dow Jones, 21 Dow Jones Industrial Average, 25 downside. See upside/downside ratio DRIP, 161, 164 DRIPs, 4 E earnings before interest and taxes, 40 cumulative, 156 per share. See EPS retained, 37, 49, 91 stability in, 147 surprise, 196 eBay, 154 EBIT, 40, 88, 206 economy, 18 efficiency driver in ROE, 99 Efficient Market Theory, 51 electronic exchange, 14 Elizabeth I, 53 Elizabeth II, 53 Energizer Bunny, 5 EPS, 40, 45, 48, 105, 130, 138, 142, 169, 173, 194, 204 diluted, 41, 61 growth, 175 plotting, 66 projected, 173 quarterly, 179 trailing, 174 equity, 34, 47 extraordinary income (loss), 40 F face value, 9 FASB, 29, 41 FCF. See free cash flow FDA, 102 Federal Reserve, 50, 108, 122 FIFO, 33 fill or kill, 15 financial strength, 196 Financial Accounting Standards Board. See FASB financial adviser, 11 financial companies, 100 fiscal year vs. calendar year, 18, 107 fixed cost, 200 Fleetwood Enterprises, 141 foreign currency, 171 free cash flow, 49 fully diluted EPS, 41 G GAAP, 29 gain, 44 definition, 39 GDP, 18, 105, 122 Generally Accepted Accounting Principles. See GAAP going public, 10 gold, 53 good till canceled, 15 Greenspan, Alan, 75 gross domestic product. See GDP growth company, 93 defined, 19 handling rapid growth, 124 growth rate, 49, 199 GTC. See good till canceled Gulf War, 75 H Hakes, Gordon, 166, 184 handling outliers, 69 Happy Meal, 53 historical principle, 48 Home Depot, 141 I IBD. See Investors Business Daily illiquid, 10, 17 defined, 35 Income Statement, 32, 37 income tax deferred, 36, 44, 89 index, 24 inflation, 53 initial public offering. See IPO insider ownership, 143 insiders, 8, 61, 197 institutions, 61, 197 intangible asset, 29 Intel, 25 interest payment, 9 inventory, 31, 32, 36, 44, 207 Invest regularly, 4 InvestFest, 6 investment gold, 53 investment club, 26, 183 investment ideas, 26 Investor Fairs®, 6 investor relations, 26, 202 Investors Business Daily, 21, 23 IPO, 10 IRS, 32, 88 issued shares, 11 J JIT, 207 Johnson & Johnson, 26 judgement, 31, 69, 121, 176, 183 K kill, 15 L large cap, 146 legs supporting a good company, 169, 179 letter to shareholders, 34 letter to the shareholder, 148 leverage driver in ROE, 100 liabilities, 9, 34, 47, 100, 198 current, 207 life cycle, 19 LIFO, 33 limit order, 15 liquidity, 10, 17, 18, 35 defined, 35 List of Figures, xi List of Tables, xiii long term debt, 207 loss, 44 lot, 15, 23 low price and fast growing companies, 124 method (a), 120 method (b), 121 method (c), 122 method (d), 123 Lynch, Peter, 20, 25, 105, 174, 197 M margin operating, 206 pretax profit, 139, 143 market capitalization, 12, 139, 198 crash, 13 maker, 13 market capitalization, 177 market order, 15 market timing, 127, 166 matching concept, 30 McDonald’s, 25, 26, 162 McDonald's, 141 Happy Meal, 53 Microsoft, 13, 25, 26 mid cap, 146 midpoint method, 67, 76 minimum quantity, 16 money manager, 20, 49 Moneyline, 26 mutual fund, 4, 20 N NAIC, 1, 183 principles, iii software, 66 NASCAR, 164 NASDAQ, 11, 21 National Congress, 6 net assets, 91, 205 net current assets, 199, 207 net income, 40, 86 net profit, 86, 206 New York Stock Exchange, 11, 21, 140 Nightly Business Report, 23, 26 normalization, 203 Nugent, Kenneth A., 59 NYSE. See New York Stock Exchange O Oakwood Homes, 141 odd lot, 15 officers, 8 on-line resources, 187 operating income, 40 operating margin, 206 optional cash payments, 4 options, 41 other exchanges, 14 outlier, 69 outstanding shares, 11 P par value, 36 partnership, 6 payables, 36 payout ratio, 132 PE ratio, 23, 85, 103, 139, 151, 174, 175, 194, 205 and PMG, 156 current, 109 explained, 103 growth indicator, 104 guides, 154 historical average, 195 market, 104 median, 194 projected, 109 relative value, 130 SCG, 145 trailing, 194 trends, 108 peak method, 67 PEG ratio, 105, 175 pension, 4 percentage earned on invested capital. See ROE PERT. See Portfolio Evaluation and Review Technique report, 172 PERT-A, 169 PERT-B, 168 Pfizer, 32, 61 PMG. See Portfolio Management Guide portfolio, 1, 6, 17, 26, 140, 156 defined, 152 Portfolio Evaluation and Review Technique, 1, 26, 140, 151, 167 Portfolio Management Guide, 1, 12, 151 PMG, 1 Portfolio Trend Report, 178 preferred method, 78, 117, 132 preferred procedure, 120 preferred shares, 36, 41, 61 pretax profit, 85, 99, 137, 151, 169, 174 quarterly, 179 pretax profit margin, 86, 87, 139, 143 price earnings zone, 153 price range, 176 price zones, 155 principle accrual, 30 conservative, 31 historical, 48 Principle of Capital Market Efficiency, 51 principles NAIC, iii profit margin net, 206 pretax, 86, 87 profitability driver in ROE, 99 projected average return defined, 180 projected PE, 121 projected relative value, 131, 140, 147 property, plant and equipment, 36 prospectus, 10 PTP. See pretax profit Q quarterly figures recent, 79 quarterly report, 33 queue, 16 quick buck, 140 R R&D, 31, 40 consequences of expensing, 101 rapid growth company, 124 rate of return compound, 176 realization revenues, 30 receivable, 35 recent quarterly figures, 79 recent severe market low, 122 recession, 18, 122, 201 recognition versus realization, 30 red herring, 10 Reinvest all your earnings, 4 relative PE, 205 relative value, 129, 140, 151, 160, 175 projected, 147 restructuring, 71 retained earnings, 37, 47, 49, 91 return on equity. See ROE return on shareholders equity, 208 return on total capital, 208 revenues, 38, 138, 142, 169, 174, 205 per share, 203 plotting, 62 risk, 5 riskless rate, 52 road show, 10 ROE, 31, 85, 90, 139, 143, 151, 207, 208 biggest driver, 101 breaking up, 96 R&D, 101 rolling EPS, 157 Roman Empire, 19 round lot, 17 rule of five, 5 S S&P 500, 24 safety, 196 sales, 96, 174 quarterly, 178 saving, 4 SCG. See Stock Comparison Guide SEC, 10, 29, 33, 193 securities analyst, 11 Securities and Exchange Commission. See SEC selling, 183 and the PMG, 166 SG&A, 39 share price high, 23 low, 23 shareholder of record, 16, 195 shareholders letter to, 34 shareholders equity, 34, 47, 208 return on, 208 statement of, 46 shareholders meeting, 8 shares, 7 common, 61 issued, 11 outstanding, 61, 205 par value, 36 preferred, 41, 61 shares vs. stock, 8 simple interest, 135 small cap, 146 sole proprietorship, 6 Southwest Airlines, 26 specialist, 13 spread, 17 SSG. See Stock Selection Guide Standard and Poors, 27 Statement of Cash Flows, 42 Statement of Shareholders Equity, 46 STB Stock Analyst, 66, 141 stock broker, 11 capital, 8 certificate, 7, 8, 16 exchange, 11 market, 11 option, 41, 88 price, 174 selling, 183 split, 22, 201 treasury, 40, 48 vs. shares, 8 Stock Comparison Guide, 1, 5, 25, 115, 140 growth comparisons, 142 management comparisons, 142 price comparisons, 144 Stock Selection Guide, 1, 5, 25, 59, 85, 115 for Clayton Homes, 189 part 3, 103 plotting, 61 section 1, 60 section 2, 86 section 4, 115 section 5, 131 stock split, 17 effect of, 203 stock vs. shares, 8 stockholders, 7 street name, 16 T Table of Contents, vii tangible asset, 28 tax corporate, 88 technical, 196 Terraceutical, 101 ticker symbol, 10, 12 timeliness, 196 Toolkit, 66, 77, 93, 117, 140, 141, 161, 168, 178 top line. See revenues total capital return on, 208 traders, 13 trading, 10 trailing EPS, 174 transfer agent, 16 Traub, Ellis, 93, 168 treasury stock, 40 trend line, 68 U upside/downside ratio, 128, 138, 176 USA Today, 21, 23 V value relative, 129 Value Line, 18, 27, 59, 77, 86, 95, 130, 139, 140, 148, 193, 194 calendar vs. fiscal year, 107 graph, 201 volatility, 196 volume, 23, 201 W Walgreen, 26 Wall $treet Week with Louis Rukeyser, 23, 26 Wall Street, 50, 165 Wall Street Journal, 14, 21, 26, 31 Wal-Mart, 25, 39, 141 Weather Channel, 27 weighted average, 94 working capital, 44, 199, 207 World War II, 19 WSJ. See Wall Street Journal Y yield, 23, 85, 108, 131, 172, 195, 205 Z zero coupon bond, 9 zone price earnings, 153 zones price, 155 zoning, 125
This calculation proceeds as follows. The earnings are $1.06 at the start of year 1; by the end of year one, earnings have increased by 17.4%; in other words, multiplying $1.06 by 1.176 gives the earnings at the end of the first year. This number turns out to be $1.24. Now, $1.24 is the earnings at the end of year 1 which is the start of year 2. The earnings at the end of year 2 is then $1.24 multiplied by 1.174. This pattern is continues for five years, yielding $2.37.
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