2 posts tagged “method”

Keep in mind that our stock market participation is limited to the very select group of stocks on our Master List. In effect, we are dealing in our market within the overall market.

At any given time, each stock on the Master List will vary as to its relative over- or underpricing when compared to the others. When a buy indication occurs, we do not want to buy the entire list. We want to choose from the list the specific issues that appear to provide the highest probabilities for appreciation.

To accomplish this objective, as well as to demonstrate valid factors that can be utilized in specific stock selection, three separate methods (earnings, yield, price) are incorporated into our portfolio modeling and each method is followed in detail in the published weekly Report.

Earnings

The most fundamental value of most corporations is earnings, which can be measured relative to stock pricing by the price/earnings ratio. The higher the P/E is, the higher the relative pricing. Conversely, the lower the P/E, the lower the relative stock pricing will be.

Lagging P/E ratios (the current stock price divided by the last full year of reported earnings) are provided in the daily stock quotations published in most major newspapers.

The problems associated with using the published P/Es are twofold.

1. The earnings of most corporations are erratic and basically unpredictable. What looks like an attractive low P/E could suddenly skyrocket with lower earnings. To overcome this, one of the conditions for inclusion on the Master List is an established record of earnings predictability. Only by confining interest to stocks with demonstrated earnings predictability can the P/E selection method be viable.

2. The published P/Es are associated with past earnings and earnings change. This is why we use earnings projections that are somewhat time-consuming to generate. To repeat, although we continue to use earnings projections in our P/E selection technique, over the many years of this technique's publication there is not a significant difference in the results obtained using either lagging earnings or projections.

Having made a reasonable attempt to overcome the obstacles associated with P/E valuations, our objective during buy indications is to purchase issues that are trading at the most attractive (lower) P/Es. Each stock on our Master List has a history of P/Es; that is, the past P/Es are available, and you can see the high and low P/Es (the P/E range) that the stock has experienced. We go back seven years in determining the range.

Not all stocks or stock groups trade in the same range. Stocks that are viewed as having superior growth will trade in a higher range than those viewed as stodgy.

During a buy indication, we want to purchase issues that are trading in the lower portion of their P/E range, thereby providing higher probabilities for appreciation than those that are trading in the upper portion of their range.

In the published portfolio model concentrating on the P/E method, generally, during buy indications, a wide variety of stocks with different P/E ranges are selling at a similar low level. Since only a very limited number of stocks are selected, a mechanical technique to determine which issues are selected from among those in similar P/E ranges is employed. You simply select those with the lowest P/E, irrespective of the range. Consequently, this selection method tends to concentrate in low-P/E stocks. In addition to the selected stocks being in the lower portion of their P/E range, they must also be selling below their price four months ago.

In our method of stock selection, we first determine which specific stocks warrant investment consideration. Qualification for consideration does not necessarily translate into actual investment. Consideration is only the first step. The actual implementation of purchase and sell decisions depends on a number of other factors which will be described after we have determined the general group of stocks we want to utilize. The qualification process is a filtering technique, through which thousands of different stocks are condensed down to a manageable number. This is not a hypothetical process. It is the actual method we use, and it is the basis from which our extraordinary high degree of accurate price forecasting was developed.

While very logical, the stock selection procedure is possibly too lengthy for the average investor. Do not be alarmed. After explaining the long method, we will describe a greatly simplified approach that is easy and quick, and that approximates the results of the longer method. The following lengthy explanation, however, is necessary for an understanding of the logic of the selection process.

The Criteria

The following qualifications are considered mandatory for the stock of any corporation to be of sufficient quality to warrant possible inclusion in our market strategy.

1. Earnings Predictability.

If you are involved in a serious hunt for a dangerous prey, your primary concern is the reliability and working condition of your weapon. Our weapon is common stock, and its specific selection is a serious (core) concern. The probability of error must be minimized to help assure survival.

Earnings are generally the most important factor in the value of a corporation. It was also mentioned that earnings generally are not easily predicted. Some corporations, however have demonstrated a consistent record of earnings predictability. Because of the existence of such corporations there is no need to rely on corporations whose earnings are less predictable.

As a rule, we consider the earnings predictability factor acceptable if the corporation has managed to meet earnings projections ±15 percent during each of the previous seven years. Disqualifying corporations that have not demonstrated a satisfactory past predictability as to earnings helps to eliminate fundamental surprises, as well as about 80 percent of all common stocks.

2. Earnings Growth.

Predictable earnings does not mean acceptable earnings. Because of the availability of corporations with demonstrated patterns of earnings growth, it is only logical to direct investment toward these issues.

The reason for this criterion is deeper than psychological reassurance. Corporations with demonstrated earnings growth get wider publicitywithin the investment community, and consequently they are considered for investment by a larger number of investors, both individual and institutional. It is from other investors that profits are taken. The greaterthe number and different types of investors involved, the easier the task of prey identification.

Keep in mind, however, that past earnings growth in itself is not enough. Future earnings projections must also indicate a pattern of growth. Themarket is most influenced by anticipation of the future. Limiting investment to corporations with both earnings predictability and earningsgrowth concentrates attention on quality, which can (but won't necessarily) help in supporting market price.

This earnings growth criterion generally halves the number of issues that were able to survive the test for earnings predictability.