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Investment Analysis Clubs Saul’s Investing Discussions
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Hi Saul:

another thing I did not asked in my last email.

You said:'Here’s a new metric – The 1YPEG - Normally a PEG ratio is the PE ratio divided by the estimated average earnings growth rate for the next five years (lower is better, of course). But that’s a total guess! No one knows what a company’s average earnings growth rate will be for five years. ’

But how the next 5 years earning growth is arrived at? isn’t it also based somewhat on the past few years earning growth just like your 1YPEG? I would not know how to factor in company specific plans or projections to arrive at a number saying that will give a good forecast of what would the next 5 years annual growth rate be for that business. I am sure there are all kinds uselessly complicated ‘methods’ but on the end may not be very accurate or relevant.

Another question about what appears under your “Ideas about how to look into the future of a stock”:

when the growth slows, the PE would tend to go down, and you message is simple: higher PE stocks are riskier essentially.

How long have you to observe the earning growth slow down before thinking you need to take an action? Arguably the lower PE positions (when you entered) would allow you more time and the higher PE positions less. When I look at stocks I often see acceleration followed by deceleration or stagnancy and re-acceleration of eps growth. Sometime this re-acceleration would not occur and sometimes the eps growth happens in a very short period or a very long period. So how do you decide to act when you are looking at that?

I get the idea that you are looking at each quarter and you would act if after a few quarter you do not see progress. Is that correct?

tj

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But how the next 5 years earning growth is arrived at? isn’t it also based somewhat on the past few years earning growth just like your 1YPEG?

Point being that 5 years in the future is a guess, but 1 year in the past is reported data. Yes, the future projection may be based on past performance, but there are all kinds of reasons – some known, understood, and predictable and many unknown because they involve things that haven’t happened yet – why the most systematically derived guess is going to fail to be an accurate prediction. Indeed, the most likely outcome is that it will not be accurate.

1YPEG is based on actual performance data. One still has to look at it carefully to look for reasons why it might be distorted by factors unlikely to pertain in the future, but at least it is data.

Going forward, there are two very different categories of things one has to keep in mind about change in growth. It is predictable that a new product will grow rapidly once it starts to be generally adopted and that as the market gets saturated that growth will slow and taper off to a steady state. As that happens, the company becomes less attractive as a growth stock. Might still be a fine company, but not high growth unless they can keep coming out with new high growth products as Apple has managed to do.

The other category is the unexpected - failure to perform, new competitor, regulatory changes, natural disaster, whatever. That can happen suddenly and one needs to be alert to the change in investment thesis.

The former is typically fairly long term and not something that will change rapidly. So, one can wait and see if new products are going to come along and spur new growth. Eventually, of course, one gets into the law of large numbers and really high levels of growth are unattainable. The latter is short term and requires vigilance, but the key is keeping in mind the investment thesis, not some arbitrary change in the numbers.

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Thanks Tamhas, very nice response.

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You are the authority, so responding in your place might seem presumptuous, but I’m sure it gets a bit repetitious after a while … not that people don’t have their own particular concerns, of course. So, one tries to help out occasionally. Nice to know that you think the help was helpful!

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yes and my point was that using actual past performance may not be much better a prediction of the future, and is also a guess.

Past performance could be something to work with if if you think there is a momemtum and the past year growth would push into the next one.

To be sure, we would need to know the specific situation of the business in question to make more useful guesses but they will always be guesses.

tj

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1YPEG is, while necessarily “past” performance because it is on reported numbers, it is certainly very recent past.

And, yes, one doesn’t take 1YPEG or any other number blindly, but, at best, uses it as a screen for to what to pay closer attention. As I have mentioned, at the least one wants to know about any special events which may have distorted the figures, e.g., discussion here about GILD and the big surge from the new drug. No one here is suggesting blind magic following the number, but rather using the number to find companies which might deserve closer attention, some of which, one might invest in.

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As I have mentioned, at the least one wants to know about any special events which may have distorted the figures, e.g., discussion here about GILD and the big surge from the new drug. - tamhas

You raise an important point, tamhas. Particularly true for pharmas when they release a new drug into the marketplace. There’s a “whoosh” as pharmacies and hospitals add the new stock to their shelves. It’s quite the phenomenon. After that initial event, life reverts to replenishment of the established stock. I believe we’ve seen the same phenomenon in ABMD. The company recently received approval for expanded use of its Impella systems. All well and good. From what I’ve gathered from AMBD’s conference calls, their medical implant devices require an entire “system”. Makes sense. I can’t envision ABMD telling surgeons to simply shove their gizmo into someone’s heart however they please. ABMD management has reported selling its “systems” to hospitals as part of its discussion of revenue increases. As a consequence, I’m not surprised there was a dramatic upsurge in sales/revenues. I benefited greatly from that surge, but I closed out my position at $99+ because that’s simply what I do when share prices skyrocket over the short-term. I look to reinvest at some point, but I don’t think ABMD has bottomed yet.

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my point was that using actual past performance may not be much better a prediction of the future, and is also a guess.

Hi tj,
To continue with what tamhas was saying:

The 1YPEG, based on real figures for the growth of earnings of the past 12 months compared to the 12 months before, is a REAL number. A guess as to what the average rate of growth over the next five years will be is such a grab-out-of-the-air made-up-number as to be laughable. Sorry about that.

Now the 1YPEG is just a screen, to let you know that things are in a neighborhood where you should look further at the stock. For me it’s usually below 1.00 where I’d be interested. However I do look at the quarters to come to see if there is something coming which will change that rate of growth. For instance in Post 12415, in my recent write-up of my new small position, LGIH, for instance, I said:

At the current price, the PE is about 19 and the rate of growth of trailing earnings is 26% and a 1YPEG of 0.71. However, based on the pre-announced closings, in the soon to be reported Sept quarter they should have earnings of about 70 cents, trailing earnings of $2.08, a PE of 15.6, and growth of trailing earnings of 45%, giving them a 1YPEG of 0.34, which is even much better.

For other companies, when I saw high current rates of earnings growth, but where those rates were falling so as to give high PE"s lack of support by high earnings rate, I’ve reduced expectations or exited positions.

But basically the 1YPEG is a screen. My classic comparison is UA vs SKX where UA has a PE of 110, and a rate of growth of earnings near 25% last I looked, and a 1YPEG of about 4.00 - and comparing that to Skechers, with a PE of 29, a rate of growth of earnings of 107%, and a 1YPEG of 0.27 - It’s evident that you get 4.00/0.27 or 14.8 times as much growth for every dollar you invest with SKX than with UA. To invest in UA you have to have other reasons - more glamor, your kids like their clothes, etc. But who knows, investing is a matter of taste after all.

Saul

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Saul, I confess to having not yet finished reading the lengthy description of your methodology, but I have been tracking this board now for a few months and your last two posts (and the threads leading up to them) have been very informative for me. Your notes re SWKS provide the context for how you measure performance with very tangible short-term measures, while watching very carefully for any changes. When you previously discussed LGIH, I hadn’t paid it any attention because the nature of its business didn’t interest me.

However, now seeing those two positions together, I think that I’m seeing more of a pattern. In particular, although you espouse that your plan is to buy for the long-term, your target returns are far, far higher than what one could expect for LGIH … a home builder will not be able to provide consistently high growth for very long … a few years perhaps? In contrast, SWKS, if it really does have a competitive advantage with its design and planning performed jointly with its customers, it could potentially maintain solid growth for many years, if IOT pans out.

So somebody correct me if I’m wrong, but the likelihood of LGIH maintaining a desired growth rate for 10 years would seem to be extremely unlikely. An average growth of 10%? Yes. But of 30% (just to pull a semi-random number based on your returns over the years), no way. SWKS? Borderline, IMHO, but possible. So it seems to me that you’re really targeting companies with a potential for 5 years or so of very solid grow, which may or may not actually last that long, but although you profess to be a long-term investor, there’s really no way to achieve those sorts of portfolio returns for a decade without switching out positions very regularly.

The Gardner brothers’ biggest gains over the years have happened due to some early buying of relatively new, small companies many years ago and not selling them. I don’t see that approach as fitting into your style, because they have only achieved those at the expense of letting me losers ride along with those winners, thus watering down the average returns to far less than what you’ve shown. I don’t see your approach as having the patience for that.

So the likelihood of a “100 bagger” is virtually zero, and even a “10 bagger” isn’t extremely likely. Your portfolio is far more likely to return those sorts of results than an individual position: for context, a 30% annual return, compounded annually, will be a 10 bagger in less than 9 years. A variant of momentum trading (i.e., based on fundamentals and not on technicals) might achieve that … is that really at the crux of the strategy?

as always, i am full of carp

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There is, of course, potential for a bubble, where an initial stocking surge is not followed by on-going sales, but I was speaking more of a surge created by a new drug, even one which takes a quarter or two to get rolling and continues to grow from there. Comparing the post surge sales or earnings to the pre surge sales or earnings creates a massive growth rate … a perfectly real one … but not a growth rate which can be reasonably sustained. This by no means rules out maintaining a very good growth rate, just that the initial comparison of post to pre surge creates unreasonable expectations.

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"The Gardner brothers’ biggest gains over the years have happened due to some early buying of relatively new, small companies many years ago and not selling them. I don’t see that approach as fitting into your style, because they have only achieved those at the expense of letting me losers ride along with those winners, thus watering down the average returns to far less than what you’ve shown. I don’t see your approach as having the patience for that. "

Carp, your point is taken but too be fair in order to achieve the gains that David Gardenr has had you would have had to automatically and without any thought had to buy each and every one of his recommendations in equal dollar amounts making it a huge portfolio and giving you little or no understanding of the individual companies. The minute you decide to pick only some of the companies they suggest then you are immediately going to see either a fall off (or if you are very lucky an improvement) in their numbers. If you followed Toms recommendations then you definitely would have faired worse than Davids recommendations.

According to Saul’s method he is hoping that he will cherry pick some of the gardeners recs that are a little more likely to do better and so far history would suggest that he has been able to do that. Also although Saul’s method might seem proprietary in reality it is common sense.
Choose a company that by 1YPEG methods is relatively cheap and is actually doing something and actually earning money, where the earnings are increasing and where the info at hand suggests that, that will not change anytime soon. Yes it does mean that he will miss out on some companies (like Amazon) that were a killer for the Gardners but clearly what his method picks up is going to be make up for it.

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CRAIGDOC66,

Thanks for those comments. I’m not disputing anything you say, just trying to get my head better-wrapped around Saul’s approach. I think that my best way of understanding it is that it’s basically an attempt to select/filter from among good ideas, but fully understanding that the goal is to dispassionately look for “short-term” fundamentals’ strength (i.e., a time horizon of maybe 3, but in any case generally no more than 5 years or so, with the willingness to cut that short at a moment’s notice) without assuming that it’s possible to identify positions that will fare well for at least 5 years.

as always, i am full of carp

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Hi, fullofcarp, Welcome to the board!

So the likelihood of a “100 bagger” is virtually zero, and even a “10 bagger” isn’t extremely likely. Your portfolio is far more likely to return those sorts of results than an individual position: for context, a 30% annual return, compounded annually, will be a 10 bagger in less than 9 years.

That’s exactly right. The two quotes below are directly from the Knowledgebase. You really, really, REALLY, should read the Knowledgebase. A lot of work went into it and it’s full of goodies. Just sayin… :wink:

I pay no attention to 2-baggers, 5-baggers, 10-baggers or whatever in individual stocks, nor do I count them. This is relevant because this way it never crosses my mind to think anything like “This stock is slowing down, but it’s a 9-bagger. Maybe I should hold it for another year to try for another 10-bagger.” Going from a 9-bagger to a 10-bagger is only an 11% gain. If I’m no longer in love with the stock, I should be able to put the money into a new stock that will be up 30% in a year, and it will never even cross my mind that I missed having a 10-bagger. Here’s another way to think about it: If you have an 80-bagger on a stock that grows to an 85-bagger it sounds exciting, but it’s only a 6% gain on your money. If you take the same money and put it into a new stock where you just get a tiny little 2-bagger, you’ve made a 100% gain on the same money. Which is why I don’t pay attention to trying to get multiple baggers. If they happen fine, but it’s not my focus.

If you were to put a small amount of money in every stock listed on the market, you would eventually pick up every 10-bagger, even every 100-bagger, that occurred. You’d be able to brag “I have fifty 10-baggers now, and three 100-baggers!” But so what? You’d just be doing as well as the markets as a whole, by definition, as you’d be investing in the whole market. And since you just invested about a hundredth of one percent in each stock, your 10-baggers would be meaningless, and even your 100-baggers would only move your totals 1%. So again, anyone can pick up lots of 10-baggers by just investing in hundreds of stocks, more if your hundreds of stocks are MF picks certainly, but the multi-baggers are irrelevant. What matters is how your total portfolio has done. If you have ten 10-baggers in 25 stocks, that’s darn good. If you have ten 10-baggers in 500 stocks, so what? I pay attention to how my total portfolio is doing. My goal, and my entire focus, is on averaging 30% to 35% per year on my portfolio. As I pointed out above, having a multi bagger on my whole portfolio is what counts, not on individual stocks.

We are talking 25 years from 1989 to 2014 and that’s a lot of time for compounding to accumulate. As of the end of 2013, I had a 273-bagger on my entire portfolio. With my 9.8% loss in 2014 that had fallen to a 246-bagger. Now, in June 2015 it has risen to over a 300-bagger.

Note: That’s not 300% of what I started with, that’s 300 times!

The Gardner brothers’ biggest gains over the years have happened due to some early buying of relatively new, small companies many years ago and not selling them. I don’t see that approach as fitting into your style, because they have only achieved those at the expense of letting me losers ride along with those winners, thus watering down the average returns to far less than what you’ve shown.

Yes, as I remember, some 60% or so of their portfolio is in Disney, due to multiple purchases of little companies acquired by Disney back in the first 2-3 years of inception. This makes the performance of new picks (which represent only 0.5% or so of the portfolio each) irrelevant. It’s all Disney and one or two others that David made early multiple purchases of.

So somebody correct me if I’m wrong, but the likelihood of LGIH maintaining a desired growth rate for 10 years would seem to be extremely unlikely.

Won’t matter to me, as I almost certainly won’t be holding for 10 years anyway. As I make clear in the KnowledgeBase, I never buy for short term, or with a goal of making a small profit and getting out. I always buy for “long-term”, meaning until I don’t feel it’s wise to stay invested in the company. With regards to LGIH, it seems to me that it’s a good buy now, for the reasons I enumerated in my analysis post. I like it and they are doing a good job. I’ll keep my position at medium size or smaller though.

Hope this helps, and please do read the Knowledgebase.

Best

Saul

For Knowledgebase for this board
please go to Post #9939.

A link to the Knowledgebase is also at the top of the Announcements column
on the right side of every page on this board

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" So it seems to me that you’re really targeting companies with a potential for 5 years or so of very solid grow, which may or may not actually last that long, but although you profess to be a long-term investor, there’s really no way to achieve those sorts of portfolio returns for a decade without switching out positions very regularly."

That’s also how I understand Saul’s approach to be.
He wished to be long term but the way he looks at the thing may cause him to take an action sooner rather than later. He is looking over several quarters and try to ride the next growth spur.

Saul- I may be characterizing your approach wrongly and I may not understand but that is how I understand it up to now. Let me know.

My difficulty is to differentiate a momentary slow down as a sign to reduce or get out, or a sign to add more because there is a longer time potential.

Certainly looking into the business can allow you to understand better the reason of a slowdown but not always. You do not know what would happen next to cause a re-acceleration if that is ever to occur. We may be taking about likelihood here.

I would like to invest in the growth business of our ‘era’ but that is hard and you need to be very lucky, and you need to hold it longer to see what happens. If you don’t you will never see that day.
Maybe Saul’s approach is a better way at making money day in and day out in the stock market.

tj

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As has been said recently, this all depends on one’s definition of “long”. Now some people may want to hold 5 years or more … maybe they don’t like making decisions or something … but if one is also looking for high growth, then it is asking a lot to hold for that long as well. Most companies are going to go through shorter periods of high growth, if only because they end up taking the share of the market they are going to get and have to come up with a new product and a new market to keep growing.

I see no reason not to recognize this and accept that the company one buys today with promising growth may keep growing for a number of years or it may not. Nice if it does, but if it doesn’t then the high growth theses has changed and it is time to move on to someone else.

There is nothing inherently magic about 1, 3, or 5 years … except for the tax implications of 1+ in a taxable account.

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Thanks for the reply, Saul. I’ve just finished planting a couple of large bags of bulbs to try to fill in some blank spaces from in front of my yard, and now that it’s too late to take a nap, maybe it’s finally time for me to sit down and relax for awhile with your knowledge base and keep at it until I’m done.

as always, i am full of carp

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My difficulty is to differentiate a momentary slow down as a sign to reduce or get out, or a sign to add more because there is a longer time potential.

tj,

That’s sort of my initial reaction as well, but given that I’m a relative newbie with investing compared to Saul (I’ve been serious at it for less than 10 years, although I dabbled previous to that), and he has documented his results, I’ll give him the benefit of the doubt for now. My “initial” reaction (after tracking this board for a few months, but not with complete intensity) is to assume that the process is imperfect, but that there’s no need for perfection in order to have very good results.

Just as some successful short-term option traders maintain a disciplined approach and follow their trading rules scrupulously carefully in order to limit their losses, in a very different approach to making money, my interpretation is that Saul uses a better safe than sorry approach to risk management. He may miss out on some big winners, but he hopefully dramatically limits his risk of big losses with this disciplined approach. And as long as there are plenty of other available opportunities, dropping one particular position isn’t such a terrible thing.

as always, i am full of carp

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Saul uses a better safe than sorry approach to risk management. He may miss out on some big winners, but he hopefully dramatically limits his risk of big losses with this disciplined approach. And as long as there are plenty of other available opportunities, dropping one particular position isn’t such a terrible thing.

Yes, there are plenty of fish in the investing sea. I don’t have to catch them all. It doesn’t matter how the stocks I’ve sold do, just the ones I’m in.

Saul

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