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Developing The Story
By Kevin Gillogly
HDIC Education Segment
April 2004
Part I
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Understanding The CompanyBy asking some basic
questions aboutcompanies, you canlearn which are likely
to grow and prosper,which are unlikely togrow and prosper, andwhich are entirely
mysterious,Peter Lynch, One Up On
Wall Street, Pg. 74.
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Investing without research is likeplaying stud poker and never
looking at the cards All you haveto do is put as much effort intopicking your stocks as you do in
buying your groceries.
Peter Lynch, One Up OnWall Street, pg. 107
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The drive of a corporationsmanagement is the singlemost influential element ofgrowth.
-- NAIC OfficialGuide, pg. 21
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However, a stock has come to yourattention What youve got so far is simply
a lead to a story that has to be developedDeveloping the story is really not difficult:at most it will take a couple of hours Itseems to me that this homework phase is
just as important to your success in stocks.
Peter Lynch, One Up OnWall Street, pg. 106
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Developing The Story
Gather Data
About the company
About its competitors
Organize InformationOn the SSG & SCG
Apply common sense
JudgmentPractice and more
practice!
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Developing The Story
Gathering the Data
Use at least three sources
Value Line &/ or S&P tearsheets Great for both company and industry data
Current news from the internet
Yahoo or MSN are the easiest to use
Company itself Best source of data even after the
Enrons and World Coms
Read the Annual Report, esp. MD&A, &other company news releases.
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Developing The Story1. Understand the economy
Where are we in the economic cycle?
How does that impact this industry?
Can be done in less than two minutes.
2. Understand the industry What is the long-term direction of this
industry? Demographics
Competition
Can be done in less than fifteen
minutes.
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Developing The Story3. Understand the company
How do they make their money?
What is the competition like?
What are the strengths & weaknessesof the company / industry?
What are the threats & opportunities of
the company / industry? Can be done in around sixty minutes.
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Stages of Growth
Break Even Point
Explosive
Growth
Startup
Matu
reGr
owth
Stabilization
enil
ceD
Best
Investment
Opportunity
Speculation
Life Cycle ofA Successful
Company
No dividends
Small dividends
(Payout ratio 35%)
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Stages of Growth The more you understand:
Type of company you are looking
Fast growth or steady grower
Slow growth or turnaround Cyclical or asset play
Its business model How it makes money
Who is its competitors? Threats it faces; Opportunities it has
Strengths it has; Weaknesses it has
Then the better your chance to select
realistic future P/Es.
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Peter Lynchs
Stages of Growth Fast growth companies
May grow at over 20% per year Have SSG graphs that look like
summit of a mountain peak
Walgreens, Lincare, Renal Care Group
The trick is figuring out whentheyll stop growing, and how muchto pay for the growth. Peter Lynch
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Peter Lynchs
Stages of Growth Steady growth companies
(stalwarts) Look for 10-12% growth per year Have SSG graphs that look like the
foothills of mountains Coca-Cola, Johnson & Johnson, AFLAC
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Peter Lynchs
Stages of Growth Slow growers
Tend to grow less than 6% per year
Have SSG graphs that look like the state
of Delaware flat Clorox, Proctor & Gamble
Usually large and aging companies areexpected to grow slightly faster than the
gross national product (3%). P. Lynch Cyclicals
Have SSG Graphs that look like thepolygraphs of liars Ford, GM, Boeing
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Developing The Story
4.Only after looking at the bigpicture can you begin to evaluate
future growth and future P/E inSection 3 of the SSG.
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Developing The Story
5. Look at the 5 year trends
Growth comes future EPS
Management is the key Value comes from making educated
guesses about future P/Es.
Never want to over pay for growth
NAIC investors look for growthcompanies that are on sale
GARP Growth At a Reasonable Price
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Developing The Story
5. Look at the 5 year trends
Where is the P/E in relation to its
history? Are the trends for high and low P/E down?
up? Or both?
Give greater weight to recent events
Compare to P/Es of the general market Compare to P/Es for its chief
competitors
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Companies with long recordsof above average growth tend to
sell at higher P/Es, but theirhighs are usually not
sustainable.
-- Handbook, 130
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Wall Street does not look kindlyon fast growers that run out of
stamina and turn into slowgrowers, and when that happens,the stocks are beaten down
accordingly.
-- Peter Lynch,
One Up On Wall Street,
pgs. 118-119
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When the growth stops When growth stops, Round I EPS will slow down
Price will drop faster than EPSbecause investors wont pay apremium for slower growth
Causing P/E contraction
When the growth stops, Round II Which can feed more price dropping
Which can cause more P/Econtraction
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ReviewAs soon as sales and/or EPS falter, growing
stocks often react as if their growth vehicle hita brick wall... Sometimes longstanding growthcompanies with previously high ratings slowdown and the price can fall by 50 percent.They are often referred to as fallen angelsthey pass our SSG test as if they were thegreatest buys in the world (except that the
most recent quarterly figures will be down).Many of those fallen companies recover andcontinue to new highs, but others cease to begrowth companies.
-- Ed Chiampi BI, April 98
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Review A companys growth prospects and
P/Es are NOT determined in a vacuum.
Understand the companys businessmodel
Understand what the competition is doing
What are its strengths and weaknesses?
What are its opportunities and threats?
Understanding what a company doeswill help make your projections moreaccurate
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Once youre able to tell the storyof a stock to your family, your
friends, or the dog so that even achild could understand it, then youhave a proper grasp of the
situation.
Peter Lynch, One Up OnWall Street, pg. 174
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Questions