1. September 10, 2004Burney Partners www.burneypartners.com Keys to Investment Success Lowell D. Pratt Jr., CFA President, The Burney Company

2. September 10, 2004Burney Partners www.burneypartners.com Jack Burney §Founded The Burney Company in 1974 l West Point Class of ’46, retired General officer l Developed Proprietary, Quantitative Analytical Process in 1950s West Point issued slide-rule was the state-of-the-art computing device for several decades §17.9% average annualized rate of return since inception

3. September 10, 2004Burney Partners www.burneypartners.com $133 v. $42 after 30 years…

4. September 10, 2004Burney Partners www.burneypartners.com How Were Returns Created? By Consistently Playing Winning Bets Asset Allocation Stocks v. Bonds Size and Style Allocation Historically, Small-Cap and Value Stock Selection More opportunity than many believe

5. September 10, 2004Burney Partners www.burneypartners.com Stock Return Advantage vs. Bonds §From 1950 to 2002, stocks have nearly twice the return (11.8% vs. 6.2%) l Higher stock returns compensate for greater Short-Term Risk Defined as either Volatility or Worst-Case Return l But, Stocks are not necessarily Riskier Depends upon Investment Time Horizon

6. September 10, 2004Burney Partners www.burneypartners.com Stock and Bond “Risk” v. Time §Volatility is conventional definition of “Risk”, but Worst-Case Return is arguably better Stocks clearly riskier than Bonds in short run Stock/Bond risk fairly comparable in the mid run Stocks less risky than Bonds in the long run

7. September 10, 2004Burney Partners www.burneypartners.com What’s a Share of Stock Worth? §Two “Right” answers l What someone else will pay Dominant during Bubbles Less popular during subsequent Bubble-Bursts l The value of an anticipated earnings stream discounted to the present Discount rate determined by prevailing interest rates plus an equity risk premium (ERP)

8. September 10, 2004Burney Partners www.burneypartners.com Valuation Math §What Investors really “Buy”

9. September 10, 2004Burney Partners www.burneypartners.com Why do Stocks Return 12%? §Long-Term Equity Returns Predetermined by Market’s Equity Discount Rate l Composed of two parts: Long-term Treasury rate Plus Equity Risk Premium (ERP) §Historically, Discount Rate averages about 12% l Currently 11.7% l Use this to forecast future equity returns

10. September 10, 2004Burney Partners www.burneypartners.com Price vs. Fundamental Worth

11. September 10, 2004Burney Partners www.burneypartners.com Fundamental’s Importance §Observed price largely fundamentally determined l S&P 500 P/V range past 10 years Low 0.62 (Sep02) High 1.32 (Mar98) Average 1.01 §Price Change v. Fundamental Worth Change l R-Square 1-mo1% 3-mo8% 12-mo45% 36-mo87%

12. September 10, 2004Burney Partners www.burneypartners.com Enduring Insight "In the short run, the stock market is a voting machine. In the long run, the stock market is a weighing machine." - Benjamin Graham Circa 1930s

13. September 10, 2004Burney Partners www.burneypartners.com “Is Now a Good Time to Invest in Stocks?” §Answer ALWAYS the same: l Long-term Investors – Yes l Short-term Investors – No l Market Timers – ABSOLUTELY NOT! §Market Timing is Ultimate Losers Game l Invest consistently in stocks, or not at all

14. September 10, 2004Burney Partners www.burneypartners.com “The Market” Doesn’t Exist §Stock Market Highly Segmented l Big v. Small l Value v. Growth l Sector: Tech v. Financial l Industry: Computer Software v. Hardware §EVERY index is biased, so no good single market gauge exists

15. September 10, 2004Burney Partners www.burneypartners.com Importance of Size and Style §William F. Sharpe l “Asset Allocation: Management Style and Performance Measurements”, Journal of Portfolio Management, Winter ’92 l Size and Style, assuming broad Sector/Industry diversification, explain 85-90% of portfolio returns §Sector diversification is a key assumption and therefore a 3 rd critical determinant of return

16. September 10, 2004Burney Partners www.burneypartners.com Size Relative Returns - Monthly

17. September 10, 2004Burney Partners www.burneypartners.com Size Relative Returns – 3-Year

18. September 10, 2004Burney Partners www.burneypartners.com Style Relative Returns - Monthly

19. September 10, 2004Burney Partners www.burneypartners.com Style Relative Returns – 12-month

20. September 10, 2004Burney Partners www.burneypartners.com The Power of Size and Style

21. September 10, 2004Burney Partners www.burneypartners.com Stock Selection’s Role §NEVER FORGET: l Size, Style and Sector account for 90% of equity return, so only 10% is leftover §Objective is Marginal Return Enhancement l Always treat Stock Selection as the minor variable of return that it is

22. September 10, 2004Burney Partners www.burneypartners.com Burney Stock Selection Process §Periodically “correlate” a factor library numbering over 1,000 (constantly growing) l Proprietary process addresses the question: “Which factors best separate strong and poor performing stocks within like industry groups?” l Models built with 50 most meaningful, most dissimilar factors

23. September 10, 2004Burney Partners www.burneypartners.com Stock Selection “Finds” §Factor composites often better than the parts GARP – Growth at a Reasonable Price PARP – Profitability at a Reasonable Price SARP – Safety at a Reasonable Price §Stock Risk not priced “efficiently” Defined as poor profitability or financial weakness Greater Risk should provide excess return, but delivers the opposite instead

24. September 10, 2004Burney Partners www.burneypartners.com Stock Selection “Chaos”

25. September 10, 2004Burney Partners www.burneypartners.com “Chaos” to Portfolio Order

26. September 10, 2004Burney Partners www.burneypartners.com Stock Selection “Don’ts” §View each stock separately Complementary parts of a portfolio §Chase Speculative Stocks Poor quality and/or earnings §Inadvertently make Size or Style bets Make them knowingly §Invest casually A cutthroat business, requires vigilance

27. September 10, 2004Burney Partners www.burneypartners.com Summary §Stocks Rule and Bonds Drool! l Stocks are NOT riskier than bonds in the long run, just higher returning §Emotion dominates stock-pricing in the short run l ERP gauge of market’s emotional state §Fundamentals dominate long-term stock-pricing l Equity Discount Rate predetermines rate of return §Size and Style are the key performance drivers l 90% variables of equity return

28. September 10, 2004Burney Partners www.burneypartners.com The Possibilities…