SSG – Sections 3, 4, & 5

Looking for Value

Recap of Section 1:

Reasonable insider & institutional ownership; Reasonable debt: Preferably under 33%; Double-digit growth in the most recent rolling

4 quarter review; Clean railroad tracks on Visual Analysis; Double-digit historical growth (look for 15%); Estimate sales and earnings no greater than

20%.

Recap of Section 2:

Pre-Tax Profit stable or increasing;

Higher than industry and competition;

Preferably 15% or more.

Return on Equity stable or increasing;

Preferably 15% or more.

Recap of Quality Issues

If the company does not pass the

Quality Issues…do not move on to

Sections 3, 4, & 5.

Bad-Quality companies look great

on the Value Issues!

On to Value!

Section 3 – P/Es and Outliers

First, removeany outliers thatdon’t seem to fit the pattern.

Can you find them in this grid?

Section 3 (cont.)

Notice the changein the average high and low P/Es whenwe remove the outliers.

Section 3 (cont.)

Compare the new average P/Es to the 5-year average and the current P/Es.

Section 3 (cont.)

Now check your estimates on the front of the SSG.

Are your P/Es realistic?What is the PEG?

It shouldn’t exceed 1.5x your 5-year EPS estimate.

Section 3 (cont.)

What if the High P/Es looks like this?

Ellis says cap the high P/E at 1.5x thePEG, but never morethan 30.

Section 3 (cont.)

And what about the lowP/E?

The 5-year average low, or the lowest in the last 5 years, will be your best choices.

Section 4 – High Price

In this visual, we’ve capped the high P/E at30 and multiplied it times our estimated future EPS from Section 1. This gives usour high price.

Section 4 – Low Price

Toolkit uses the last full year’s EPS to calculate the low price.

But some prefer to use the next 4 quarters EPS since we “are” looking into the future.

Section 4 – Low Price (cont.)

Section 4 – Low Price (cont.)

Here are our options

There are many differing opinions on the selection of low price…

…but Ellis says to be mindful of your selected P/Es and earnings, then choose Option #1.

Section 4 - Zoning

Toolkit automatically figures the zones, which we have set to 25/50/25.

Section 4 – Understanding Zoning

Sell

Maybe

Buy 1/3

1/3

1/3

P oten tia l H igh P rice$100

P oten tia l Low P rice$10

T op o f B uy$40

T op o f M aybe$70

1/4

1/4

1/4

1/4

3 :1 U ps ide -D ow ns ide R a tio$30

Section 4 – Relative Value

Once you have found a “buy”, always checkthe Relative Value. We’re looking for 85-110%.

Section 4 – Relative Value (cont.)

Relative Value: Current P/E divided by Signature P/E

Tells us whether we missed something when we addressed the “quality” issues.

Lets us know if the price is unusually highor low. A call to investigate.

Section 5 – The Final Section

Section 5 gives us the results of our efforts;• Total annual return, and• Compounded annual return.

Section 5 (cont.)

Total annual returnis our estimated growth divided over5 years. Without thepower of compound-ing, we need 20% to double our moneyevery 5 years.

Section 5 (cont.)

And on the otherside, we have ourcompounded return.

Here, we only need15% to double our money every 5 years.

These are best-case scenarios!

Section 5 (cont.)

But also noticethe ProjectedAnnual Return.This is our select-ed EPS x the average P/E—a more conservative compounded figure.

This is an option you must select from yourPreferences Tab in Toolkit.

Summary of Sections 3, 4 & 5

Either eliminate outliers or cap your high P/E at a PEG of 1.5, not to exceed 30.

Use the average 5-year low P/E, or the lowest P/E in the most recent 5 year period.

Consider using the forward 4 quarters for your estimated low price.

For growth stocks, use Option #1 for low price.

Summary of Sections 3, 4 & 5

Always set the zoning for 25/50/25 to ensure we have a true 3:1 upside ratio.

Look for a Relative Value between 85 & 110. And look for an compounded rate of return of

at least 15%, which will double our money every 5 years.

(See the handout for more specifics)

The End