Modified: November 2, 2006 Simplicity of the SSG

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3 Credits C. H. Hodgkin, from a note on the I-Club-List June, This material is ©copyrighted and may be used for BetterInvesting educational purposes only.

4 Annual High and Low Price We can look historically at a stock's price performance, especially it's high and low prices each year

5 Price Chart on the SSG

6 Historical Earnings Per Share (EPS) We can look historically at a stock's earnings per share (EPS)

7 EPS Chart on the SSG

8 Calculate High and Low PE Ratio  From high price, low price, and earnings we use simple arithmetic to calculate two more numbers:  High PE ratio is high price divided by EPS  Low PE ratio is low price divided by EPS

9 High and Low PE Chart on the SSG

10 Formula for PE Ratio  The formula is PE = Price / Earnings  By simple algebra, we re-work the formula to read: Price = PE x Earnings  Substitution gives two similar formulas: High Price = High PE x Earnings Low Price = Low PE x Earnings

11 Predicting High and Low Prices  Ergo, if we project what the earnings will be in five years…  and can project what the high and low PE ratios will be in five years…  Then, we can project what the high and low prices will be for the next five years

12 Stock Requirements  What this requires is that we select stocks that: 1. We think we can project the earnings in five years with reasonable accuracy. Our assumption is that, if nothing else changes dramatically, a stock with a basically straight earnings line for the past ten years will continue to grow at approximately the same rate, so we can project its earnings in five years. 2. The PE ratios have been relatively consistent for the past five to ten years so we can predict that they will remain approximately the same for the next five years.

13 In Conclusion…  Now, of course there are complexities  But the core principle of the SSG is simplicity itself

14 Summary  Take the PE = Price / Earnings ratio and recast it to read Price = Earnings x PE  Then pick stocks where we have some confidence that the Earnings and PE values can be reasonably projected five years from now  Multiply and you have the price range over the next five years

15 Now, isn't that simple?

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