Forum Archive Index - June 2000

["nick" <acummin@es.co.nz>]

> > Rule 1  p/e must be less than 10
> > Rule 2  eps must be expected to grow in next forecast year
> > Rule 3   Gross dividend yield of at least 8%
> > Rule 4   must be within 20% of 52 week low compared with high
> > Rule 5  Sell when p/e over 12
>
> Interesting post Nick.  I somewhat disagree with points 1, 2, 3 and 5
> however.
>
> Rule 1 for example.  If you had a stock that historically traded at a
> p/e of 20 because of a track record of strong growth, and had fallen to
> a p/e of 15, it could be a much better buy than a stock trading at a p/e
> of 9 with a much weaker business.  While i regard myself as a "value"
> investor (although i hate the value/growth debate) I am happy to buy a
> stock at a P/E much higher than 10 if I believe this is "value", and
> will avoid a P/E of 8 if I believe there is less value.  What counts is
> quality of earnings, consistency of earnings, and how well management
> deploy retained earnings and new equity.  If management does this very
> well, a higher P/E is justified and 15 could be value - especially if
> historically the stock traded at, and deserves, 20.
phil

                I agree with you here, there are many company's undervalued
in nz at the moment (arnt they always) i regard montana wines as one such
company, trading at around pe 15 which has good prospects.
       However, like i said each system rule on its own would not work but
combined i think they eliminate weak companies.  Sure they are not the great
growth company's that is why they dont have ridiculous p/e around 40-50.
       The fact that i only select those forecast to grow eps means that the
next year if the shareprice stayed the same then the p/e would be
ridiculously low
and this wont happen. Either the share price will rise or a major problem
will
arise for the stock.   However major problems can happen for any stock and
those falling from a great high p/e hurt themselves much more.
            Many of the stocks on low p/e were once flying high on big
multiples (breiley)
  but by the time the system picks them out a big shakeup of management
etc has already happened and they are ready to move forward again.
nick


> Rule 2 I have a definite problem with.  Some of the best opportunities
> come when you have a company which has a solid track record, and the
> long term prospects appear sound, but because of a "glitch" or the
> sillyness of the market, the expectations are doom and gloom for the
> next year.  If you are a "buy and hold" investor, some of the best
> investments will be ones you can buy at rock bottom because of very low
> expectations, chuck in a drawer for a year, and then just sit back.
         phil

         Not sure what you mean by a sillyness of the market leading to loss
of eps.   I agree with you about the rock bottom ones and these are
precisly the stocks the system will pick up.  Take restaurant brands they
had a bad
year and the perception among many investors is that they are poorly run
etc.
  However in the meantime they have been sorting themselves out, the
expected
increase in earnings is a sign of this, the market tends to lag behind and
in some ways sees
the company as it was not how it is now


> Rule 3 Obviously this rule is designed just for the NZ market, as it
> would eliminate most overseas shares.  My only point here - what is
> better, Telecom giving out 8% , investing nothing in their business and
> eventually having major issues, or Telecom using their mass of cash to
> improve their business and give consumers little reason to switch to
> competitors.  If cash cannot be deployed at a high rate of return, it
> should be paid out.  If it can, a high dividend is lunacy.
phil

           Agree with you here, strong growth company's probably
need to reinvest all their money to stay ahead, however these generally are
not the type of  company's which trade on a p/e less than 10. Sure they grow
but as an investor you usually have to pay a high price for the earnings


> Rule 5 My only problem here is by trying to sell at a p/e of over 12 you
> are shooting yourself in the foot.  As a "value" investor, you are
> missing many opportunities - as you have noted, only 3 investments meet
> your criteria.  Therefore, to sell as soon as it goes up a little gives
> you a "trader-style" profit.  However, if you are in at a low price, and
> the business performs, the "value" investor really needs to stick around
> for many years reaping the rewards.  There will generally be a time when
> the general market is extremely bullish about a stock or the whole
> market - thats when you sell.
phil

         Only three investments meet the criteria at the moment, but there
are probably seven or eight in the course of the year.  Fletcher building
was one
picked out at 2.00 a share , nice yield and growth.  Im sure there will soon
be more
when the next (inevitable ) market correction hits.   Thats partly why i
think the
system will work well. In times when markets are overpriced it probably
wouldnt
pick out any investments (i wouldnt want it to. ) However when the market is
down
there will be more opportunities, this means that most shares will be bought
near bottom.
       In fact many of the current stocks in the 10-15 p/e rage will come
into range.
                 Also when there is a crash those who bought at very cheap
p/es will
not suffer nearly as badly as those holding the high multiple stocks

        As for selling at 12p/e i just included that as a guidline, if a
company was clearly
racing up at a huge rate i would hang on for the ride.  However 12p/e is
higher than it
looks for the following reason.
          Assume a company has the following stats and is assumed to grow by
10%
its next earnings

       share price  1.60
       eps              0.20
       p/e                 8
next year (with 10% growth
       share price   1.76
       eps              .22
       p/e                 8

        So in a year the share price has increased 10%  plus
around 10% in dividends have been pocketed and the p/e is
still only 8.

        However a company is likely to be rewarded for its growth
so the share price would probably expand more.  To reach a p/e
of around 12 though the company would have to increase its share
price by around 60% in that year .
nick


       Your views on the three shares are interesting, the fact that
their share prices are all very weak suggests that many investors
agree with you, and have negative expectations
  However this is from the contrarian perspective
exactly the time to buy them, in the expectation that sentiment
is too negative and the shares are oversold,
       Buy into weakness , sell into strength

 nick



> My problem with the above criteria is probably best explained with the 3
> shares that it selects.  First Force, which while unexciting, does
> qualify as a "value" share which I have bought and will buy.
>
> As for Brierley, the dividend must be in question and using a p/e ratio
> on a company dependent on "transactional" profits is always risky.  When
> I see Brierley, I see a punt, but I don't see a lot of value - at least
> by my definition.
>
> Restaurant Brands, frankly, I wouldn't touch with the biggest bargepole
> I could find.  Sure, their earnings per share are expected to grow,
> presumably because of Starbucks and the acquisition of Eagle Boys.  But
> Eagle Boys were kicking Pizza Hutt's ass - from what I gather,
> Restaurant Brands are going to rebrand the Eagle Boys stores as Pizza
> Hutt.  I've also heard funny things about what is going to happen to
> individual stores.  Bottom line is the reason 50 people bought Eagle
> Boys franchises is because they wanted to own their own business - not
> because they wanted to work for a large listed firm.  The reason Eagle
> Boys did so well is because each store was owned by someone with his
> money tied up, who cared about the results.  From what I can gather, its
> unlikely many of the franchise owners will stick around (many won't be
> wanted anyway) so what are you left with? - 50 stores, with much weaker
> branding, run by early 20's people put through a head office management
> course who don't really care.  Sounds a lot like Pizza Hutt to me.
>
> While I may look like a complete dork in a year when Restaurant Brands
> announce much better earnings due in part to the Eagle Boys acquisition,
> long term, if I bought anything, it would be a Pizza Haven franchise.
>
> Cheers,
> Phil
>
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