1. Finding Quality: Getting a 2 nd Opinion (or How To Use the S&P Quality Ranking) By Kevin Gillogly For Happy Destiny Investment Club July 2005

2. 2 Measuring Managerial Ability – Benjamin Graham and David Dodd Security Analysis “A statement of actual earnings, over a period of years, with a reasonable expectation of that these will be approximated in the future. The record must cover a number of years, first because a continued or repeat performance is always more impressive than a single occurrence, and secondly because the average of a fairly long period will tend to absorb and equalize, the distorting influences of the business cycle.”

3. 3 What is Quality? As long-term investors, we look for quality growth companies As long-term investors, we look for quality growth companies What does quality looks like? What does quality looks like? On the SSG it is consistency of Sales, Pre- Tax Profit (PTP) margins, and EPS On the SSG it is consistency of Sales, Pre- Tax Profit (PTP) margins, and EPS Is it well managed? Is it well managed? On the SSG it is the trends on the graph and in Sec. 2 (Evaluating Management) On the SSG it is the trends on the graph and in Sec. 2 (Evaluating Management) Want a 2 nd opinion? Want a 2 nd opinion? Where do you turn? Where do you turn?

4. 4 Finding Quality Myriad ways to find quality without doing a SSG. Not one is perfect. All have some limitations. The Stock Check List The Stock Check List SSG on training wheels SSG on training wheels Looks at a sample of the past 7 years Looks at a sample of the past 7 years Quick cut; “ Wrong” years can lead to misinterpretation Quick cut; “ Wrong” years can lead to misinterpretation Take Stock software Take Stock software Shows the Better Investing concepts in 4 clicks Shows the Better Investing concepts in 4 clicks Goes through quality points found on the SSG Goes through quality points found on the SSG Can be conservative; Can miss some good choices Can be conservative; Can miss some good choices

5. 5 Other Forms of Quality Non Better Investing forms: Kausch Meisheri’s Quick Analysis Kausch Meisheri’s Quick Analysis Looks at the trends of the past 10 years worth of Value Line (VL) data Looks at the trends of the past 10 years worth of Value Line (VL) data Quick cut; but can’t tell if the price is right Quick cut; but can’t tell if the price is right Mark Robertson’s 60 Second Equity Analysis Mark Robertson’s 60 Second Equity Analysis Also uses VL data Also uses VL data A Quality Ranking that can be compared across industries and uses projections in the calculations A Quality Ranking that can be compared across industries and uses projections in the calculations

6. 6 How Strong Are These Companies? Most of the previous metrics look at sales, EPS and margins. What about financial stability? What about financial stability? How strong is management? How strong is management? Can a company survive a financial hit? Can a company survive a financial hit? Where do we turn? Where do we turn? metric n., a system of measurement

7. 7 Looking For Independent^ Quality Ratings* Sources: Morningstar Stock Investor Morningstar Stock Investor Newest on block Newest on block Uses “Stewardship” grade & Star Rating Uses “Stewardship” grade & Star Rating Value Line Value Line Peter Lynch “like hiring your own analyst” Peter Lynch “like hiring your own analyst” Financial Strength & Earnings Predictability Financial Strength & Earnings Predictability Standard & Poor’s Standard & Poor’s Used by founders of Better Investing Used by founders of Better Investing Quality Ranking Quality Ranking ^ = reputable w/ no brokerage business * = no price component

8. 8 S&P Quality Ranking Formally known as S&P Earnings and Dividend Ranking Formally known as S&P Earnings and Dividend Ranking Proprietary measure started in 1956 Proprietary measure started in 1956 Attempts to measure Graham & Dodd’s sustainable earnings power Attempts to measure Graham & Dodd’s sustainable earnings power See quote on page 2 See quote on page 2 Measures long-term growth and stability of earnings and dividends. Measures long-term growth and stability of earnings and dividends. Focus is on the last 10 years worth of data Focus is on the last 10 years worth of data Covers over 3,500 US based companies Covers over 3,500 US based companies

9. 9 Why Use It? According to back-testing by S&P when compared to lower ranked companies, high quality rankings have: Less risk; Less risk; Lower debt levels, higher profit margins and higher return on equity; Lower debt levels, higher profit margins and higher return on equity; Less likely to engage in accounting manipulations; Less likely to engage in accounting manipulations;And Outperformed the S&P 500 index Outperformed the S&P 500 index

10. 10 How To Use It Simple and quick way to determine if company is worth studying Simple and quick way to determine if company is worth studying Screening Shorthand Screening Shorthand Simple and quick way to determine if company is worth keeping Simple and quick way to determine if company is worth keeping Portfolio Management Shorthand Portfolio Management Shorthand Uses letter grades Uses letter grades 8 in total 8 in total Remember to do your own research!

11. 11 Where To Find It Two places: S&P Company Report (aka “tearsheet”) S&P Company Report (aka “tearsheet”) On-line Premium Service (OPS) On-line Premium Service (OPS) Can drop straight into Toolkit (TK5), Stock Analyst (SA 3.1), and Prospector (NSP 2.6) Can drop straight into Toolkit (TK5), Stock Analyst (SA 3.1), and Prospector (NSP 2.6) Not available in Classic (NCP 2.3) Not available in Classic (NCP 2.3) Can also be used in MS Excel Can also be used in MS Excel

12. 12 S&P “Tearsheet” For Most Companies

13. 13 S&P “Tearsheet” For Smaller Companies

14. 14 S&P Quality in Stock Analyst

15. 15 S&P Quality in Toolkit 5

16. 16 Translating the Grades * A+ Highest( 2%; 81 companies) A+ Highest( 2%; 81 companies) A High( 6%; 204) A High( 6%; 204) A- Above Ave.( 6%; 233) A- Above Ave.( 6%; 233) B+ Average(16%; 576) B+ Average(16%; 576) B Below Ave.(19%; 702) B Below Ave.(19%; 702) B- Lower(26%; 966) B- Lower(26%; 966) C Lowest(24%; 872) C Lowest(24%; 872) D In reorg.( 1%; 36) D In reorg.( 1%; 36) LIQ Liquidation LIQ Liquidation NR Not Ranked(3670 companies) NR Not Ranked(3670 companies) * Source: OPS 3705 cos. w/ Quality Rank Jun 05

17. 17 Translating into NSP * A+ Highest8 A+ Highest8 A High7 A High7 A- Above Ave.6 A- Above Ave.6 B+ Average5 B+ Average5 B Below Ave.4 B Below Ave.4 B- Lower3 B- Lower3 C Lowest2 C Lowest2 D In reorg.1 D In reorg.1 NR Not Ranked0 NR Not Ranked0 * NAIC Stock Prospector

18. 18 S&P Quality as a Cross Check Can Be Found In screening of Prospector In screening of Prospector

19. 19 S&P Quality as a Cross Check Can Be Found In the Portfolio Portion of Stock Analyst In the Portfolio Portion of Stock Analyst

20. 20 Benefit of S&P Quality Rating Combines some key aspects of the SSG Growth and stability of earnings Growth and stability of earnings Growth and stability of dividends Growth and stability of dividends

21. 21 Limitations of S&P Quality Rating Misses key aspects of the SSG No forecast of future Sales & EPS growth rates No forecast of future Sales & EPS growth rates Does not help determine future value Does not help determine future value Misses key aspects of the SCG Measuring to its peers Measuring to its peers Measuring the better return Measuring the better return

22. 22 From Quality to Performance Top Return to Risk Was Not Found in stocks with the highest ranking, “A+” Top Return to Risk Was Not Found in stocks with the highest ranking, “A+” Two notches below, “A-”, preformed best. Two notches below, “A-”, preformed best. Price Premium of top ranking Price Premium of top ranking That’s still leaves over 200 companies (with a ranking of A-) to examine that could be potential purchases That’s still leaves over 200 companies (with a ranking of A-) to examine that could be potential purchases

23. 23 Quality to Performance S&P Quality Ranking will not help finding undiscovered “gems” of the stock market: Penalizes companies not paying a dividend Penalizes companies not paying a dividend Highest they earn is a “A-” Highest they earn is a “A-” Also favors companies paying a dividend Also favors companies paying a dividend Lowest they earn is a “B-” Lowest they earn is a “B-” Penalizes young small companies Penalizes young small companies Good companies > 10 years may not be ranked Good companies > 10 years may not be ranked No ranking of foreign companies No ranking of foreign companies Used only on US based companies Used only on US based companies

24. 24 Final Thoughts S&P Quality Ranking has … No price component No price component Therefore no “buy” or “sell” aspect as found in other S&P proprietary measures (STAR & Fair Value/Outlook) Therefore no “buy” or “sell” aspect as found in other S&P proprietary measures (STAR & Fair Value/Outlook) No projected return No projected return As in Sec. 5c of the SSG As in Sec. 5c of the SSG Which is our reason for studying stocks Which is our reason for studying stocks Use as your starting point Use as your starting point First cut First cut Remember it’s limitations Remember it’s limitations

25. 25 Final Thoughts Use the S&P Quality Ranking … Like a pilot use your instruments Like a pilot use your instruments Several different gauges to tell the same thing Several different gauges to tell the same thing Use in conjunction with other metrics Use in conjunction with other metrics VL Financial Strength VL Financial Strength Quick Analysis Quick Analysis 60 Second Equity Analysis 60 Second Equity Analysis It is ok to have overlap It is ok to have overlap Cross-check your work on the SSG Cross-check your work on the SSG The visual analysis The visual analysis Evaluating Management Evaluating Management

26. 26 What We Learned The Value of a simple quality metric The Value of a simple quality metric How To Eliminate Stocks Before Doing a SSG How To Eliminate Stocks Before Doing a SSG How To Monitor Existing Stocks How To Monitor Existing Stocks Another use for OPS Another use for OPS Another Benefit of using NAIC Software Another Benefit of using NAIC Software

27. 27 Questions?

28. 28 Further Reading Brain Lewis articles Brain Lewis articles Sept. 04 Better Investing (BI) Sept. 04 Better Investing (BI) Aug. 04 BITS (expanded article) Aug. 04 BITS (expanded article) ICL list (NAIC Chat room – free to anyone) ICL list (NAIC Chat room – free to anyone) August 12 to 23, 2004 August 12 to 23, 2004 www.standardandpoors.com www.standardandpoors.com www.standardandpoors.com Equity Research (near top) Equity Research (near top) Analytical Methodology (left side) Analytical Methodology (left side)