What Do you Use the SCG For? The Stock Comparison Guide (SCG) is BetterInvesting's solution to aid you in your quest to select the best stock candidate from among up to five good quality stocks. After the Stock Selection Guide has help you find past, present, and future quality and estimate the risk and reward of purchasing the stock at the current price, the SCG will help you decide which among the candidates offers you the best stock for quality and value. For an expanded overview of the SCG, click here. The SCG looks at two basic areas: Quality & Valuation These can be further subdivided into: Quality 1. Growth A. Historical rate & consistency and projected rate of Sales Growth B. Historical rate & consistency and projected rate of EPS growth. 2. Efficiency A. Size and Trend of Pre-Tax Profit Margin B. Size and Trend of Return on Equity Valuation 3. Risk A. Average Historical P/E B. Current P/E C. Relative Value or Projected Relative Value D. UpSide/DownSide Ratio 4. Reward A. Total Return OR Projected Average Return (PAR) The Stock Comparison Guide For an example of the SCG, click here. Judgment and the SCG Like the SSG the SCG is a guide for your good judgment, not a replacement for it. There are several areas for you to apply judgment. Different people have ideas as to which are the most important items to them. In other words some items carry more weight with them than others. This is a form of judgment. ToolKit 5's SCG has the ability for your to weight your judgments from within the program. With experience most people just come to find what they consider most important to them. Unfortunately, experience is what you get 15 minutes after you need it. As a beginning point the software defaults to equal weighting. ( 1, 2, 3, & 4) Quality - Growth When considering Growth you have to consider the rate at which the company has grown sales and EPS. This is not an indication of the future, but it does speak to what management has been capable of in the past. Likewise the consistency or smoothness of the data lines speaks to the quality of management and to the predictability of future growth. A company such as Walgreens with smooth data line will be easier to forecast growth than for one with more "bumpy" growth. A company with really erratic growth is very difficult to forecast, but hopefully would not have made it past the SSG screening process. Obviously the most important element of these three are the projected rates of growth for sales and EPS. Although EPS growth is what everyone looks at, realize sales is "top line" growth from which EPS ultimately flow. Growing EPS faster than sales is hard to do for most companies. In summary, we are looking for the stock with the highest rates of projected and historical growth for sales and EPS with consideration for consistency or smoothness. (4, 5, & 6) Quality - Efficiency The two main measures of management's efficiency are the Pre-Tax Profit Margin (how efficiently they convert sales into profit) and Return on Equity.(how efficiently thay have use the corporations equity to generate profit) Remember that the SSG is a progressive form and when you're looking at these sections you've already satified your concerns about managements ability to grow the company's sales, pre-tax profit, and EPS. In other words, these results were obtained with acceptable rate of growth for those metrics. (5) Pre-Tax Profit Margin (PTP Margin) At this stage you should already have looked at an industry average and selected companies with average or above average numbers. Within an industry the company with the the highest number is the most efficient at turning sales into profit. An even trend is acceptable and an upward trend may even be better. Opposing thoughts here. A company with an even trend is already operating at peak efficiency whereas a company with an upward trend has had some room for improvement and may have additional improvment potential in the future. Of course, if this continued forever the company would eventually produce more profit that sales! Not likely unless you STILL like Enron or Worldcom. The upward trend or potential to improve the PTP margin could also lead to a situation in which EPS grows faster than sales. If you are conservative and limit your EPS growth forecast to the growth rate of sales, you might get a nice surprise. Use your judgment. (6) Return on Equity (ROE) The Return on Equity (ROE) is a measure of how efficiently management has used the company's equity to generate income. Remember debt can be an inflator of ROE. For a brief overview of how this occurs and how ToolKit 5 can screen for this see the "Components of ROE" by clicking here. By this point you should have looked at industry averages and be considering companies with average or above average numbers. The company with the highest number is the most efficient at generating income with the company's equity. The trend is also important. Look for an even or upward trend. As a reminder, you may wish to check debt level trends for the companies too. (7) Insider Ownership An additional consideration under this category is insider ownership. Insider ownership is considered important becasue if management has a vested interest, i.e., they own a lot of the stock, they want to see it go up just as much as you do. The percentages to look for depend upon the size of the company. For a large company 1% or 2% may constitute a significant ownership whereas a much smaller company may require 20% or 30%. Be careful of companies in which insiders own a large portion (> 40%) becasue they may vote their interest only rather than truely represent all of the shareholders. After considering the company's size, the company with the largest inside ownership is selected. Summary for Quality In summary, we're looking for the company with the highest number and and even or upward trends in PTP margins and ROE and significant insider ownership with consideration for company size. After considering all of the above, hopefully, you'll come to a conclusion about which company has the best quality or possibly that they have equilivent quality. Next consider valuation - risk and reward.
Valuation - Risk vs. Reward When I look at the valuation section I'm ( emphasize "I" here because others will & should be different) looking at three basic areas risk - Relative Value & Upside/Downside Ratio and Reward - Projected Average Return (PAR). There are many people with different portfolio goals. For example I am fairly young. I'm still working and have a sufficient income to suppport my lifestyle. I'm a growth investor: dividends are not needed for income. Another investor may rely upon dividends for income and also seek growth as protection from inflation. They may highly consider dividends whereas I don't put a lot of thought in about them. My point is different people have different goals and the SCG will accomodate them. I also do not aggressively pursue offensive portfolio management so I use PAR as an estimate of potential return. If you don't know what offensive management is you may not practice it either and may wish to use PAR rather than Total Return. Click here to read an overview of offensive management. Again, I'm looking at Risk - Relative Value & Upside/Downside Ratio and Return - Projected Average Return. (PAR) My point to all of this is to decide what is most important to you and use those criteria to select which stock is a better value. Perhaps begin with these three and add whatever you like. If one stock has superior quality and clearly better value, your selection should be easy. If both stocks are of similar quality, then the one offering better value should be the winner. In the case where one stock is of higher quality, but lower value you're back into using your judgment. One final idea presented by Bob Adams is to start off the election process with up to five companies within the same industry, do the analysis, discard the stock with the lowest score, and repeat this process until you have the two strongest candidates left. Then pick the winner of those two to purchase. This prevents weaker stocks from diluting the strong points of the other stocks. The following is a listing of potential criteria you may with to consider for value. Risk - the potential for loss or harm (8) 5 year estimated EPS This is a heretofore unseen measurement of risk. It is calculated by dividing the sum of your forecast eps for the next five years (from the 5 year future side of the visual analysis) by the current price. Think of it as "What percent of the current price will all of the earnings from the company for the next five years represent?" The company with the highest percentage is the selected. Anyone with the logic behind this please add it here! (9) Price Range Over the Last Five Years Self explanatory. (10)Present Price Self Explanatory (11, 12, 13, 14, 15, & 16) P/E Values Values for the Highest, Average High, Average, Average Low, Lowetst P/E for the last five years, and current P/E are listed for each stock. One way to use this is to look for the stock with the highest Average P/E during the last five years and select it. Then select the stock with the lowest current P/E. Of course this is similar to selecting the lowest Relative Value or Projected Relative Value which is an option in ToolKit and I look at it. Others may disagree. (17, 18, & 19) Price Zones The Buy - Hold - Sell zones for each stock is listed. I don't use them for selection. (20) Present Price Range List where the currrent price is the buy - hold - sell zone for each stock. Select all stocks with Buy signals. I don't use them because I look at the Upside/Downside Ratio below. Any stock with an US/DS Ratio of 3:1 or more will automatically be in the buy zone I see this as redundant. (21) Upside/Downside Ratio Indicates the ratio of potential gain to potential loss from the current price to your estimates of the reasonabilly expected high and low price for the next five years. I select anything 3:1 or more. Reward (22) Current Yield The dividend as a percentage of the present price. Select the highest if income is important to you. (23) Combined Estimated Yield - Total Return The expected rate of return from a stock's dividend and simple rate of return per year for each year of the next five years. Used in the days before computers could easily calculate the compounded rate of return called Total Return. This is an option in ToolKit. A 20% combined estimated yield is equivilent to a 15% total return. ToolKit offers another optional rate of return aclled Projected Annual Return. This is the return from dividends and price appreciation if purchased at the current price and sold in five years at the forecast EPS and the Average P/E. This differs from Total Return in the Total Return assumes you sell at the Average HIGH P/E. Other Considerations (24) Number of Common Shares Outstanding Self explanatory (25) Dilution from Debentures, Warrants, and Options (26) Percent Payout (27 & 28) Optional metrics In ToolKit you may select any two of the following parameters. (I'll bet you're smart enough to copy the info onto the paper form if you really want to look at three or more!) Debt/Capital 33% or less (25% if using long term debt) Earning Stability (R2) - indicator of how "straight" the line is. I look at the SSG with special attention to the last five years and the last year to look for smooth growth and constant growth. I believe R2 looks equally at all 10 years of data so I don't use it. ToolKit 5 will print a minin SSG from its SCG if you click the stocks name at the top. Relative Value - I look for values between 85% to 110%. less than this is an alert to investigate why investors are willing to pay less than the five year average. More than 110% and I may be overpaying for the stock's earnings that will manifest itself in the P/E coming back to its average (RV 100%) and hurting my potential price appreciation. Total Sales - Self explanatory. I do want ot know the size of the company, but I've probabilly factored this into my growth projections. Projected Relative Value - Relative Value using Projected P/E. Your choice. P/E:Projected Growth Rate (PEG) If the P/E asks "What are investors willing to pay for one dollar of a compay earnings?", then PEG asks "What P/E are investors willing to assign to a growth stock's EPS growth rate?" If a stock whose EPS is growing at 10% and it carries a P/E of 15, then its PEG is 1.5. Conventional wisdom says you should look for values between 1 and 1.5. (29)Optional Metrics (30) Where Traded The Stock Comparison Guide For an example of the SCG, click here. Comment on this Page Last Modified 2009-02-10 |
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