1 Portfolio Management Using PERT NAIC CompuFest 2004 Ralph Seger, CFA Please turn off cell phones

2 National Association of Investors Corp This document is copyrighted © and may be used for NAIC educational purposes only.

3 Write down your investment objectives What are you trying to accomplish? How much risk is appropriate for your situation? What investment techniques are you going to use to accomplish your investment objectives?

4 What is (is not) a Portfolio? Securities to accomplish your objectives NOT helter-skelter collection

5 Potential Investment Objectives Provide for future financial security Save for long-term goal Save for short-term goal ( less than 3 years)

6 Speculation vs Investing

7 Investing to provide for your financial future: Invest in common stocks of well- managed growth companies selling at a reasonable price Invest on a regular basis Reinvest income and capital gains Diversify

8 NAIC Tools Help Online Premium Service (OPS) data SSG – to evaluate and select growth stocks PERT to help you manage your portfolio

9 What is PERT? Why PERT?

10 Characteristics Common to PERT and the SSG Growth stock oriented – sales, pre-tax profits and EPS Evaluation of trend of pre-tax profit margins P/E ratio evaluation Relative Value Total Return PEG – P/E as percent of growth rate

11 PERT Reports are in Two Forms PERT-A for a single company PERT Report for a portfolio

12 PERT-A Worksheet--Zebra

13 Right hand side PERT -A Zebra

14 PERT-A Worksheet Graph Zebra Technologies Trailing four quarters trend is displayed Percent pre-tax profit margin Annualized rate of growth of sales, pre- tax profit dollars, EPS

15 Zebra—PERT A Graph

16 PERT Report - Example

17 Partial PERT Report Column B – dividend Column C - name of co Column D - yield Column E - Est EPS for 12 months in the future

18 PERT Report Column E Very Important! Estimated earnings for next 12 months Valuation aspects of PERT Report is forward-looking based on estimated EPS

19 Estimated EPS Zebra Technologies--Default 16% D E BC $ x 1.85 = 2.14

20 Recommended Method for Obtaining Estimated EPS for PERT Use Barron’s Research for a company. Adjust estimated EPS to 12 months in future. Better since it involves judgment of analysts, not mechanical projection. Open PERT report, options, enter estimated EPS. Insert user estimated EPS for each stock.

21

22 Barons--Zebra… Est earnings….

23 The Fundamentals

24 Sales, EPS, Pre-Tax Profit Margin How are they doing compared to your SSG? Are sales, EPS and pre-tax profits growing? If not, why not? Find out why. Pre-tax profit margins have a major impact on EPS. Avoid jumping to conclusions from short-term results.

“The Big Three:” Sales, EPS, % Pre-tax Income (% pre-tax profit) Are they growing? Is the trend up? Are they growing at about the same rate? If one of the three shows a deflated growth rate, find out why If sales are trending down, can earnings continue to rise? How long can % pre-tax income decline before it effects earnings? Remember, quarterly results are short-term

26 Quarterly (short-term!) earnings per share Columns F, G, H Date quarter ended $$ amount of quarterly EPS Percent change from a year ago quarter

27 PERT Report Column H Percent change of quarterly EPS compared to a year earlier Compare with your judgment from your SSG in column V. Is it comparable? Remember, one quarter is not a trend, but it may be an alert signal to good or bad news. Look for reasons. Look at the trend in PERT-A worksheet

28 Compare Column H with V (Zebra) 16.0%

29 PERT Report Column J Percent change in quarterly sales from a year ago Are sales growing? Are sales relatively in tandem with earnings? If top line sales falter, EPS growth will disappoint

30 Look at Sales (Zebra)

31 K, L, M often First Indicator of Future Problems Declining pre-tax profit dollars and percent margins are quickly translated into declining EPS and stock price Watch the trend on PERT-A worksheet and a giant SSG

32 Partial PERT Zebra Columns K, L, M

33 Pre-tax columns K, L, M are often the first indicator of future potential problems If you see pre-tax profit headed downward, watch out! More than one quarter of downturn in pre-tax profit margin may indicate earnings will be going down; consequently, the price of the stock

34 PERT Column N, O Looks at the trailing last 4 quarters EPS Compare Column O with Column V your projected EPS rate of growth The percent growth in column O (trailing) and my projected percent growth---pretty close?

35 Compare Column O with Column V Is stock meeting your expectations? N O V

36 Caution! The Toolkit software calculates the average P/E ratio from decisions made in the SSG for Section 3, Columns D and E, High and Low P/E Ratios. It does not use decisions made for P/E ratios used for Sections 4A and B. It is necessary to calculate manually the judgment of your future average P/E ratio by averaging P/E ratios in Sections 4 A and B.

37 Find Out WHY!

38 PERT-A Chart -- Zebra

39 Note difference between “annual data” and “trailing four quarters data”

40 PERT Report Uses Estimated Earnings for: Current P/E Relative Value is projected RV PEG Ratio Upside/downside ratio % Compounded Annual Rate of Return Estimated High Price (4 years)

41 Right Hand Side of PERT

42 PERT: Columns P, Q, R Current P/E price used is the latest update you have put in the program earnings figure used is estimated earnings for next four quarters (Column E) Relative Value is projected RV

43 Check Relative Value Monthly Relative Value less than 100 or 110 may be a buying opportunity if fundamentals of profitability and growth are ok

44 Indications of a possible over valuation If current P/E (P) is significantly higher than the average high P/E (S) ……and…… If current Upside/Downside ratio (Y) is one or less

Compare 5 Year Average P/E with Current P/E

46 On the other hand…… A very low P/E ratio can be a danger signal What do others know that we don’t know?

47 Column V Your Projected Growth Rate from SSG Compare with actual growth rate

48 PEG Ratio Column W u P/E as % of Growth Rate u Uses estimated growth rate (V) u Is preferable to have below 110 or so for a buy

50 Upside/Downside Ratio (Y) Measures Risk When we buy a stock, we want an upside of at least 3 When the upside gets below 3, but not below 1, it may be a “hold”

51 0.7

52 Estimated Total Return Column Z Based on anticipated compound annual rate of appreciation Plus dividend yield “Compounded Annual Rate of Return”

53 Total Return Total return is average yield plus compound annual rate of price appreciation. These two add up to total return.

54 Columns AA and AB are the estimated low and high prices

55 Considerations for Evaluating the Data Whether the percentage changed in quarterly and last 4 quarters’ data are performing as expected or at least satisfactorily The trends of the percentage changes as well as the absolute values are performing as expected

56 …..considerations The pre-tax profit margin is consistent or rising The tax rate is consistent uTry to understand the reason for any significant changes—if declining, find out WHY  Generally the last 4 quarters’ data smoothes the fluctuations in the quarter to quarter data

57 When changes occur, find out why! Are the changes permanent or temporary? Don’t sell a high quality stock because of one or two quarters of bad news. NAIC experience shows that it is best to hold high quality stocks during periods of over-valuation and add to holdings during down periods.

58 Questions? Seminar ID CF 4404 Please fill out your evaluation form

59 Speculation: Too much risk Lack of system, logic Based on tips Foolish bet

60 PERT Sorted by Ascending Relative Value

61 Look at Fundamentals

62 Look at Fundamentals