PERT

PERT Report is a one line summary of quality and value data for each stock in the portfolio. Pretty neat eh?  Notice that the name of the stock is listed on the far left side of the report and that data for each stock is listed on a single line.  The "Quality" and "Value" sides of PERT Report are clearly labeled on the example above.

The use of the PERT Report only has significance if you're purchased quality stocks with the SSG and it should always be viewed with the SSG in mind.  Just as on the SSG, always evaluate Quality issues before Value issues.  Ignore the Value informaton for stock of poor quality.

Monitoring Quality - Defensive Portfolio Management

The SSG found historical quality, confirmed that quality was continuing at the time of purchase, and aided you in forecasting the future quality of the company.

BetterInvesting's "Rule of Five" reminds us that one in every five stocks we purchase using our BetterInvesting techniques will have unanticipated problems with its fundamentals and need to be replaced.

The PERT Report's job is to make sure the actual results are meeting your forecast expectations.

Doing this is simple. Look at the column in the VALUE section labeled "Estimated EPS Growth Rate". This is your estimate of the EPS growth rate for that stock.

Now look back at PERT Report's Quality section.

The top of this area is labeled EPS, Sales, Pre-Tax Profit (PTP), and Trailing Twelve Month (TTM) EPS.  The values here show the latest quarter's results compared with the same quarter a year ago.  The comparison is expressed as a percentage change.  You simply compare that percentage change with your estimate for EPS growth (shown in column V over on the Value side).

Look at Lowes. Its estimated EPS growth rate is 17%. Now check the actual percentage change for quartely EPS, Sales, PTP, and TTM EPS which are 18.7%, 17.3%, 19.8%, and 19.4% respectively. Those are all above the forcast rate of EPS growth.

Checking that the actual growth is meeting or exceeding our expectations satisifies the growth component of our definition of quality, but quality = growth + efficiency, so we still have to check effeciency.

Efficiency is measured by Pre-Tax Profit Margins and Return on Equity. Only Pre-Tax Profit Margin is reported on a quarterly basis. In the PERT Report it is reported next to the quarterly results for Pre-Tax Profit. The actual profit margins for the quarter are shown rather than the % change. What we look for are two numbers very close to each other that indicated little or no change. In this case the latest quarters value is 11.2% and that of a year ago's quarter was 11.0%. Pretty close.

There. You've checked the quality of a stock by verifying the growth rates are meeting or exceeding your expectations.

Try the same exercise with Harley Davidson and then with Affiliated Computer Services so you get the hang of it.

The computer programs flag these conditions for you by marking them in pink. You can quickly see which stocks require more inspection.

Any stocks that are not meeting your expectations need to be examined more closely to see what is going on with them.  The PERT-A report can assist with making a closer examination.

Monitoring Valuation - Offensive Portfolio Management

Just as we did when we originally look at the stock with the SSG, having passed the quality examination, we look at the stock for value. This is done with the same process we've experienced on the back of the SSG. No surprise there. Remember the PERT Report is just a one-line summary of the SSG.

On the SSG we had four tests of a stock's value (remember B.U.R.T.?):

• Buy zone
• Upside/Downside Ratio 3:1 or more.
• Relative Value between 80% and 110%.
• Total Return contributing to the portfolio's desired rate of return (15%). 

Anytime you have an US/DS ratio of 3:1 or more you automatically have a stock in the "Buy" zone regardless of which zoning method you are using.  Because of this PERT Report only lists the last three, U. R. T.  (In PERT they are listed in a different order so using R.U.T may help you remember them more easily.) The zone is unnecessary.

Let's take a look at PERT Report's Value section.

Again, only for stocks with intact current quality:

To check a stock's valuation look for:

A 'buy' will have an US/DS ratio of 3:1 or more, a Relative Value of between 80% and 110%, and a Total Return adding acceptably to the portfolio's return (15%).

You might wish to add to a stock in this position if you have available cash and it fits within your personal diversification framework.

Look at the valuation section for Lowes. You'll see a Relative Value of 81.4, US/DS of 4.1:1, and a Total Return of 23.7%. This would signal a candidate for purchase.

Anything with an US/DS of less than 3:1, and a Relative Value of over 110% will be in the 'hold' zone or above. You wouldn't want to purchase it right now. Maybe next month it will be down in price and become a 'buy.'

Look at Renal Care Corp.'s valuation section. Relative Value 103, US/DS 2.3, and Total Return of 15.7%. This wouldn't be in the buy zone because the risk indicator, the US/DS ratio is too low. Maybe next month.

Whereas we were only concerned with a purchase decision when we didn't own the stock, we now have to further consider our position in a stock when our valuation indicators point to a 'sell'.

They do this when Relative Value > 150%, US/DS < 1:1 and Total Return much less than acceptable.

Consider this scenario.

You are looking to buy a car. You've selected a model that can be purchased most any day for $20,000. A salesperson offers to sell you the car for $20,000. It isn't a bargin, but it is a fair deal. If he offered you the same car for $25,000 you'd most likely laugh and graciously decline the offer. If he offered you the car for $15,000 you might snap it up as a bargin.

This is what we do with sections 3, 4, & 5 of the SSG. Look for bargins to buy!

Consider this scenario.

You bought the car! You own it. It is still worth $20,000. A fellow comes along and offers you $15,000 for your car. Do you sell? Hopefully not. What about a $20,000 offer? or a $25,000 offer? or a $30,000 offer? How about $30,000 for your $20,000 car AND you can turn right around and buy another car of equal or greater quality for $20,000?! You would have a nice car and and extra $10,000!

This is similar to what happens when we own a stock whose valuation indicator go into the 'sell' zone.

When the stock becomes so overvalued that there is little five year price appreciation left you may wish to replace it with a stock of equal or greater value and greater potential return.

Our three indicators will show Relative Value > 150%, US/DS Ratio < 1:1, and Total Return far below acceptable levels.

Fortunately, this portfolio currently has no grossly overvalued stocks.

If it did, then you should consider preparing a more optimistic SSG, one with less conservative judgments, and if the numbers still look grossly overvalued consider replacing the stock with one of equal quality and better potential return.

In essence this is similar to the reason you need to sell stocks with fundamental flaws in the previous quality sections.

There you missed price appreciation because the stock had failed to meet you expectations. You lost money because you were in a stock with little price appreciation when you could have been in another stock with good quality and price appreciation.

Here the price has gotten way ahead of the fundamentals and it will take time for the fundamentals to catch up. You could replace this stock, capture the excess profits, and invest in another stock of equal or greater value whose price is in line with or behind its fundamentals. You'd have lost money because you were in a stock whose price was too high and going nowhere when you could have locked in the excess profit and moved to another stock with price appreciation potential.

Before you actually decide to replace an overvalued stock, you should do an optomistic SSG. Whereas we've always been taught to be conservative with out judgments on the SSG, in this case we want to be less conservative with our growth rate estimates and selections for high and low P/E ratios.

If the optomistic SSG still says it's grossly overvalued and a suitable replacement can be found the next step is to use the Challenge Tree or the Computer version, The Challenger, to help you decide if the trade makes sense when you factor in sales commissions and taxes.  Click here for further discussion of the costs of selling.

To put this in perspective consider three levels of stock investing. Each has a higher level of expected return.

Level 1 Total Stock Market Index Fund - Historical return 10.5%

Level 2 BetterInvesting methodology selecting stocks and only using defensive portfolio management. Higher than total stock market, Level 1. Use PAR rather than Total Return for anticipated return.

Level 3 BetterInvesting methodology selecting stocks and using both defense and offensive portfolio management. Higher than Level 2. Use Total Return for anticipated return.

Monitoring Diversification

When you designed your portfolio you set down an idea of how many stocks you wanted in your portfolio and perhaps guidelines for maximum amount that one stock could occupy.

Sugggest guideline range from "No more than 15% in one stock" to "Less than twice your ideal weighting in a stock."

Whichever gudeline you use you should periodically check to see how your actual diversification and your planned diversification compare.

ToolKit shows the percentage of portfolio for each stock based upon dollar amount in the PERT Report. ToolKit also shows the diversification by "Size of Sales" in the PERT Trend report.

If you wish to view diversification by sector, Jim Thomas has an Excel spreadsheet that will import data from your ToolKit database and show sector diversification. In addition to this it also shows size and current and future Value Diversification.  I.E., based on the dollar value of the entire portfolio, how much does each stock represent now and five years in the future, if they all grow as you have forecast. I like to use it to see potential overgrowth of one stock.

Jim's spreadsheet is available by clicking here. You'll need Excel 2000 or later. I urge you to read the instructions to get as much out of the spreadsheet as possible.