Newsletter March 23, 2002

investment-picks.com Newsletter March 23, 2002

New Members:

Thanks again for joining. I trust will find the information worthwhile. For my American friends, I don’t yet have many American stocks. However I hope to add more in future. Also you find that most of the Articles are applicable to any market.

Updates:

Since last time… are available for Biovail (weak buy, but consider for speculation), Stantec (weak buy) and Canadian Western Bank (Buy for the long term)

A new report is available for members only. I had promised recent new members a free report and this is it. BW Technolgies is a solid growth company, it’s not a particularly cheap stock, but its current growth rate does leave plenty of room for up-side. It’s well managed and highly profitable. Perhaps the really easy money has already been made, but I think there is still money on the table.

As you can appreciate my reports pack a lot of analysis into a concise package. I am finding that the effort to add new companies is increasingly a large one due to the thorough analysis provided. In future most of the newer Buy and Strong Buy picks will be available for a small charge instead of being free. The Performance data on this site is very detailed, open and honest and I believe clearly shows the value of the work presented here.

Stocks to Buy…

I plan to contact members soon with an offer of several new research reports for sale.

Why Buy Stocks That Are Fully Valued?

Recently I have focused my attention on identifying and analyzing companies that have excellent profitability in terms of return on equity. Sometimes the result of my analysis is that the company looks very good, but the stock appears to be fully valued.

One view is that such a stock should not be bought.

On the other hand if we are looking at a great company with excellent prospects then their is really nothing wrong with paying a fair price for the stock. My Price to Value calculation usually assumes I need at least a 9% return. So if the stock is fully valued and I pay that price and my earnings “projection” comes true then I earn 9% per year, which is really not bad. And if I only earn 6% per year, that’s not too bad either. Usually the stock value calculation of a really good company actually leaves plenty of room¬† for up-side. If the earnings are currently growing at 25% but if I conservatively assumed only 12% for the ten year projection then there is lots of up-side.

The bottom line is that there is probably nothing wrong with paying full value for great companies. However, this does not mean it’s okay to over-pay. If you pay a price that is implicitly assuming 25% growth then you are assuredly leaving yourself with more down-side than up-side room.

The Canadian Economy…

Click here to see my views on how to improve the Canadian Economy

Preservation of Capital

We hear a lot the importance of this. Some people consider that in order to preserve capital you must pretty much avoid the stock market. They forget that what they then expose themselves to is loss of purchasing power, because in the long term the bond and GIC markets barely keep up with inflation. See article that illustrates this dramatically.

My view is increasingly that preservation of capital means avoiding buying stocks that have a significant chance of going bankrupt or suffering losses of 75% plus. This will include most pre-production research type companies. The only safe way to invest is those is to do so on a portfolio basis. A very aggressive mutual fund is a good idea here. Investing in only one or a few of these companies is pure gambling. If you must do it, you should do so with only a small portion of your portfolio.

Of course all stocks are subject to “volatility” (it’s interesting how that word is used exclusively to mean down-side volatility and not up-side volatility). If you invest in solid companies at reasonable values with little chance of bankruptcy then in the long term you are extremely unlikely to lose capital. Sure, you may lose money on paper. But if you keep the company and if it’s a “good” company then it is almost sure to eventually recover any temporary losses. And, in all likelihood a portfolio of such stocks will provide a good positive return over the longer term. When Warren Buffett talks about “don’t lose money” he is not talking about temporary market losses. He tends to studiously ignore the market. His view is that the market’s opinion of value is not superior to his own opinion and he is more than willing to wait for the market to come back to a sensible value. For good companies that keep pulling in and retaining profits, there is an almost gravitational upward force on stock prices over the long term.

In conclusion you risk capital when you speculate on lottery ticket type stocks (okay for your “mad” money, not your main wealth). You don’t really put your capital at much risk when you buy reasonably priced “good” companies, no mater what the market might temporarily say.

Graphs:

It’s worth taking a few moments to explain how the graphs that I include with each stock research report work. It took me a long time to settle in on this type of graph. Essential features are the logarithmic scales and the use of the same scale for the revenue per share and the earnings per share lines. In most cases the top of the logarithmic scale is 100 times higher than the bottom. (In a few cases of extreme growth, I have to set the top at 1000 times the bottom.)

“Normal” non-logarithmic graphs are almost meaningless. On a normal graph a 10% rise in earnings over ten years can easily be made to appear as a 45% degree or higher slope. Using non-logarithmic scales the slope of the line indicates absolutely nothing about the level of growth until you look very carefully at the numbers on the scales.

The primary purpose of my graphs is to show you the growth. On my graphs a 45% slope would usually require a growth of 100 times over the 5 to 7 year period that is usually shown. So a small slope on these graphs constitutes quite a rapid growth. On these graphs if the revenue growth is parallel to the earnings growth then both are growing at exactly the same rate. The same would not be true on non-logarithmic graphs.

Sometimes you will note that the purple adjusted profit line is present but the blue non-adjusted profit line is absent. That is caused by one of two things. Either the blue profit line is coincident with the adjusted profit which is often the case. Or it could mean that the actual profit is negative and therefore does not graph on the logarithmic scale. You can usually tell which situation obtains from other information in the report.

An unfortunate aspect of my graphs is that a pretty robust growth can actually look fairly flat. My software unfortunately does not fill in the numbers on the scales between 1 and 10 or between 10 and 100. If it did you would be able to read the growth better.

The important point to remember is that it does not take much slope on these graphs to illustrate a pretty substantial growth rate. And the distance which the earnings graph is below the sales graph illustrates profit on sales. A large distance is indicative of a lower margin business.

The next time you read one of my reports, study the graph closely.

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Regards,
Shawn Allen
Editor
investment-picks.com