As a new club, we are currently educating ourselves on the
SSG using the Investors Toolkit. One area that we are
struggling with is calculating future high and low prices.

In setting up the calculation using Investors Toolkit, the
task is to apply judgement to the Average High and Low P/E.
As we have all seen recently, highs and lows have been
significantly off the historical averages. Recommendations
are to never project future P/E greater than 20, which will
obviously keep the low P/E prediction somewhere less than
20.

The numbers that you apply for Average high and low P/E have
a significant effect on the final analysis of a stock. For
example:

Using 5-year Value Line data (1996-2000) for Oracle resultrs
in the following:
Average High P/E = 82.0
Avearge Low P/E = 31.1

If we accept these averages, the final result puts the stock
in the Buy Zone at it's current price. However, if we apply
the very conservative estimate of 20 and 10 for average high
and low P/E's, the end result puts the stock in the Hold
Zone.

If we eliminate some of the 5-year data (years that are too
high or low), we can come up with yet another set of average
high and low numbers.

Can you offer any quidelines that will help in applying
judgement to this calculation and aid in deciding which
average high and low P/E to use?

We appreciate any advice you can provide us with! Thank you
for your time.

Debbie....


Here are a few of my thoughts on selecting a high and low PE:

The software and NAIC's approach uses the average of the past 5 years, yet
as you observe, this can lead to unreasonably high projected PE values. For
the PEs, I look at where the stock has been and look for any trends in the
five year's data. For example, if the PE is trending down, then make use of
that insight and adjust my results downward. Look at the PE in relation to
what you know about the industry. When the government was advocating
publicly funded health care, the PE of the health care industry dropped. If
you're looking a the historical data, knowledge of that might affect how you
would interpret the data and project going forward. Look for trends and any
reasons that might explain them. Use that insight to assist in projecting
forward values.

A second concept to consider is the PEG, or price to growth ratio. It's a
concept I first saw used by Peter Lynch in his management of the Magellan
Fund, and simply put, it says that the PE ratio divided by the growth rate
should be about 1. If a company has a high PEG, then it may be overpriced,
and if less than 1, it may be a value. Therefore, if you know a company is
growing at 10%, you probably should not use a PE of 25 in your high PE. A
PE of 15 may be more reasonable.

Third... you mention that PEs are lower than their historic levels.
Actually, PEs are very high relative to their historic levels. When looking
at the 30 year average PE for the S&P composite, the composite PE is
currently somewhere near 30 and its historic average is somewhere near 20.
I don't have the exact numbers in front of me, but I reference Vanguard's
quarterly newsletter which has a very nice chart of the PE over the past 30
years with the average indicated. I remember the early 80's when PEs were
closer to 10 to 15 for high PE companies, and many companies had a PE in
single digits. Hard to imagine. But consider the downside potential if we
were to return to such economically conservative times and valuations. Your
stock trading with a PE of 30 (about S&P average today) and dropping to a PE
of 10 would loose two thirds of its value. I think it's very likely that we
could see a return to the 30 year average and that would mean the S&P
composite would fall to 2/3 of its current value.

Fourth... Consider where the company is in its life cycle and size.
McDonald's is not going to have the same growth rate now as it did years ago
when it was a small company because its markets are now saturated and the
easy growth opportunities are gone. In addition, it's easier for a small
company's earnings to grow than a large company because large companies
often have huge overhead, bloated salaries and inertia that must be
overcome. Microsoft and GE revenues are already more than the gross
domestic product of many nations... it's difficult to double that number.
It's easier to get a rowboat to double its speed than a freighter. Older,
more mature companies have fewer new sales opportunities for its products.
Products that have been around a long time just don't grow sales unless the
company moves into a new market. Consider peanut butter... it's not likely
to generate growing sales and income in the US because there are many
competitors, the market is static, demand has been met. Unless some new
whizbang peanut based product comes onto the market, sales of peanuts will
most likely grow with the general economy. This is why we look for
companies bringing their products into new markets such as Europe or
Asia.... which represent sales growth opportunity if the product is new in
that market. Growth in sales and revenues will drive the price of the stock
higher than for an

Very few companies can maintain a growth rate for sustained periods. I seem
to remember reading that only IBM was able to maintain a 15% growth rate for
a long period (10 years?). If we then look to the PEG ratio, perhaps we
should not select a high PE more than 20-25 for long established companies.
I personally often use 20 and many times less. I feel it's better to be
conservative and miss an opportunity than to buy at a high price only to
have my equity vanish when the market turns less bullish.

Finally, remember that the high PE, as determined through NAIC's
methodology, is a five year average that might be reasonably expected to
represent the norm high PE going forward. This can be an unreasonable
expectation in that it assumes that the past recent five years will
represent the next five going forward. If we've gone through a bullish
period where PEs are high and we're on the cusp of entering a bearish period
(where PEs will not be as high), then you should not use the past five year
average to extrapolate the future because doing so will yield results that
are unrealistically high. In this case, you need to bias your results
downward. You might use the PEG concept, historical PEs taken from bearish
economic periods, or a SWAG (Some wild a$$ guess). You're trying to
estimate a reasonable high PE. Err on the side of caution... a lower chosen
PE will drop the hoped for high price in the SSG model, resulting in a lower
buy price.

If others have any further ideas, I'd love to hear them. NAIC's model needs
to be tweaked by the judgment we apply and this is a skill we all need to
develop.

John Munn
Capitol Investors Investment Club, Troy, NY
Cross Country Investment Club, an on-line club












----- Original Message -----
From: "Debbie Secrist" <dsecrist@bivio.com>
To: <club_cafe@bivio.com>
Sent: Monday, September 17, 2001 11:01 AM
Subject: club_cafe: Calculating Future High and Low Prices


> As a new club, we are currently educating ourselves on the
> SSG using the Investors Toolkit. One area that we are
> struggling with is calculating future high and low prices.
>
> In setting up the calculation using Investors Toolkit, the
> task is to apply judgement to the Average High and Low P/E.
> As we have all seen recently, highs and lows have been
> significantly off the historical averages. Recommendations
> are to never project future P/E greater than 20, which will
> obviously keep the low P/E prediction somewhere less than
> 20.
>
> The numbers that you apply for Average high and low P/E have
> a significant effect on the final analysis of a stock. For
> example:
>
> Using 5-year Value Line data (1996-2000) for Oracle resultrs
> in the following:
> Average High P/E = 82.0
> Avearge Low P/E = 31.1
>
> If we accept these averages, the final result puts the stock
> in the Buy Zone at it's current price. However, if we apply
> the very conservative estimate of 20 and 10 for average high
> and low P/E's, the end result puts the stock in the Hold
> Zone.
>
> If we eliminate some of the 5-year data (years that are too
> high or low), we can come up with yet another set of average
> high and low numbers.
>
> Can you offer any quidelines that will help in applying
> judgement to this calculation and aid in deciding which
> average high and low P/E to use?
>
> We appreciate any advice you can provide us with! Thank you
> for your time.
>

John,

Thanks so much for your feedback!! I really appreciate the
time you took to offer your thoughts. It helped to
strengthen my direction in applying the judgement piece of
the SSG. In my mind and as you note, "erring on the side of
caution" can only increase your chances of picking the
better performing stock, especially given the recent bullish
market. Your information about looking at trends and the
company's life cycle will be very useful in this task also.

One note: Not sure where I led you astray about my
understanding of the historical PEs. I do feel that they
have been siginificantly higher in recent years versus
lower. This is what is frustrating to us because we can't
seem to find a stock that is in the Buy zone currently when
we use the more conservative estimates of growth and
high/low PE. I too feel that we will see a return to the 30
year average, and thus feel a conservative approach is
called for at this time.

What a time to be in a learning mode!! Five to six years
ago, would have put a whole different spin on the learnings.
Your insight has been very useful in helping me and my club
to establish a method of moving forward in our stock study.
Thanks so much for your help!!

Debbie Secrist
Treasurer
Hot for Stocks Investment Club

John R. Munn wrote:
> Debbie....
>
>
> Here are a few of my thoughts on selecting a high and low PE:
>
> The software and NAIC's approach uses the average of the past 5 years, yet
> as you observe, this can lead to unreasonably high projected PE values. For
> the PEs, I look at where the stock has been and look for any trends in the
> five year's data. For example, if the PE is trending down, then make use of
> that insight and adjust my results downward. Look at the PE in relation to
> what you know about the industry. When the government was advocating
> publicly funded health care, the PE of the health care industry dropped. If
> you're looking a the historical data, knowledge of that might affect how you
> would interpret the data and project going forward. Look for trends and any
> reasons that might explain them. Use that insight to assist in projecting
> forward values.
>
> A second concept to consider is the PEG, or price to growth ratio. It's a
> concept I first saw used by Peter Lynch in his management of the Magellan
> Fund, and simply put, it says that the PE ratio divided by the growth rate
> should be about 1. If a company has a high PEG, then it may be overpriced,
> and if less than 1, it may be a value. Therefore, if you know a company is
> growing at 10%, you probably should not use a PE of 25 in your high PE. A
> PE of 15 may be more reasonable.
>
> Third... you mention that PEs are lower than their historic levels.
> Actually, PEs are very high relative to their historic levels. When looking
> at the 30 year average PE for the S&P composite, the composite PE is
> currently somewhere near 30 and its historic average is somewhere near 20.
> I don't have the exact numbers in front of me, but I reference Vanguard's
> quarterly newsletter which has a very nice chart of the PE over the past 30
> years with the average indicated. I remember the early 80's when PEs were
> closer to 10 to 15 for high PE companies, and many companies had a PE in
> single digits. Hard to imagine. But consider the downside potential if we
> were to return to such economically conservative times and valuations. Your
> stock trading with a PE of 30 (about S&P average today) and dropping to a PE
> of 10 would loose two thirds of its value. I think it's very likely that we
> could see a return to the 30 year average and that would mean the S&P
> composite would fall to 2/3 of its current value.
>
> Fourth... Consider where the company is in its life cycle and size.
> McDonald's is not going to have the same growth rate now as it did years ago
> when it was a small company because its markets are now saturated and the
> easy growth opportunities are gone. In addition, it's easier for a small
> company's earnings to grow than a large company because large companies
> often have huge overhead, bloated salaries and inertia that must be
> overcome. Microsoft and GE revenues are already more than the gross
> domestic product of many nations... it's difficult to double that number.
> It's easier to get a rowboat to double its speed than a freighter. Older,
> more mature companies have fewer new sales opportunities for its products.
> Products that have been around a long time just don't grow sales unless the
> company moves into a new market. Consider peanut butter... it's not likely
> to generate growing sales and income in the US because there are many
> competitors, the market is static, demand has been met. Unless some new
> whizbang peanut based product comes onto the market, sales of peanuts will
> most likely grow with the general economy. This is why we look for
> companies bringing their products into new markets such as Europe or
> Asia.... which represent sales growth opportunity if the product is new in
> that market. Growth in sales and revenues will drive the price of the stock
> higher than for an
>
> Very few companies can maintain a growth rate for sustained periods. I seem
> to remember reading that only IBM was able to maintain a 15% growth rate for
> a long period (10 years?). If we then look to the PEG ratio, perhaps we
> should not select a high PE more than 20-25 for long established companies.
> I personally often use 20 and many times less. I feel it's better to be
> conservative and miss an opportunity than to buy at a high price only to
> have my equity vanish when the market turns less bullish.
>
> Finally, remember that the high PE, as determined through NAIC's
> methodology, is a five year average that might be reasonably expected to
> represent the norm high PE going forward. This can be an unreasonable
> expectation in that it assumes that the past recent five years will
> represent the next five going forward. If we've gone through a bullish
> period where PEs are high and we're on the cusp of entering a bearish period
> (where PEs will not be as high), then you should not use the past five year
> average to extrapolate the future because doing so will yield results that
> are unrealistically high. In this case, you need to bias your results
> downward. You might use the PEG concept, historical PEs taken from bearish
> economic periods, or a SWAG (Some wild a$$ guess). You're trying to
> estimate a reasonable high PE. Err on the side of caution... a lower chosen
> PE will drop the hoped for high price in the SSG model, resulting in a lower
> buy price.
>
> If others have any further ideas, I'd love to hear them. NAIC's model needs
> to be tweaked by the judgment we apply and this is a skill we all need to
> develop.
>
> John Munn
> Capitol Investors Investment Club, Troy, NY
> Cross Country Investment Club, an on-line club
>
>
>
>
>
>
>
>
>
>
>
>
> ----- Original Message -----
> From: "Debbie Secrist" <dsecrist@bivio.com>
> To: <club_cafe@bivio.com>
> Sent: Monday, September 17, 2001 11:01 AM
> Subject: club_cafe: Calculating Future High and Low Prices
>
>
> > As a new club, we are currently educating ourselves on the
> > SSG using the Investors Toolkit. One area that we are
> > struggling with is calculating future high and low prices.
> >
> > In setting up the calculation using Investors Toolkit, the
> > task is to apply judgement to the Average High and Low P/E.
> > As we have all seen recently, highs and lows have been
> > significantly off the historical averages. Recommendations
> > are to never project future P/E greater than 20, which will
> > obviously keep the low P/E prediction somewhere less than
> > 20.
> >
> > The numbers that you apply for Average high and low P/E have
> > a significant effect on the final analysis of a stock. For
> > example:
> >
> > Using 5-year Value Line data (1996-2000) for Oracle resultrs
> > in the following:
> > Average High P/E = 82.0
> > Avearge Low P/E = 31.1
> >
> > If we accept these averages, the final result puts the stock
> > in the Buy Zone at it's current price. However, if we apply
> > the very conservative estimate of 20 and 10 for average high
> > and low P/E's, the end result puts the stock in the Hold
> > Zone.
> >
> > If we eliminate some of the 5-year data (years that are too
> > high or low), we can come up with yet another set of average
> > high and low numbers.
> >
> > Can you offer any quidelines that will help in applying
> > judgement to this calculation and aid in deciding which
> > average high and low P/E to use?
> >
> > We appreciate any advice you can provide us with! Thank you
> > for your time.
> >