SSG – Sections 3, 4, & 5
Looking for Value
Recap of Section 1:
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Reasonable insider & institutional ownership;
Reasonable debt: Preferably under 33%;
Double-digit growth in the most recent rolling
4 quarter review;
Clean railroad tracks on Visual Analysis;
Double-digit historical growth (look for 15%);
Estimate sales and earnings no greater than
20%.
Recap of Section 2:
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Pre-Tax Profit stable or increasing;
Higher than industry and competition;
Preferably 15% or more.
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Return on Equity stable or increasing;
Preferably 15% or more.
Recap of Quality Issues
If the company does not pass the
Quality Issues…do not move on to
Sections 3, 4, & 5.
Bad-Quality companies look great
on the Value Issues!
On to Value!
Section 3 – P/Es and Outliers
First, remove
any outliers that
don’t seem to
fit the pattern.
Can you find
them in this grid?
Section 3 (cont.)
Notice the change
in the average high
and low P/Es when
we remove the
outliers.
Section 3 (cont.)
Compare the new average P/Es to the 5-year
average and the current P/Es.
Section 3 (cont.)
Now check your estimates
on the front of the SSG.
Are your P/Es realistic?
What is the PEG?
It shouldn’t exceed 1.5x
your 5-year EPS estimate.
Section 3 (cont.)
What if the High P/Es
looks like this?
Ellis says cap the
high P/E at 1.5x the
PEG, but never more
than 30.
Section 3 (cont.)
And what about the low
P/E?
The 5-year average low,
or the lowest in the last
5 years, will be your
best choices.
Section 4 – High Price
In this visual, we’ve capped the high P/E at
30 and multiplied it times our estimated
future EPS from Section 1. This gives us
our high price.
Section 4 – Low Price
Toolkit uses the last full year’s EPS to calculate
the low price.
Section 4 – Low Price (cont.)
But some prefer to use the next 4 quarters EPS
since we “are” looking into the future.
Section 4 – Low Price (cont.)
Here are our options
There are many
differing opinions on
the selection of
low price…
…but Ellis says to be mindful of your selected
P/Es and earnings, then choose Option #1.
Section 4 - Zoning
Toolkit automatically figures the zones, which we
have set to 25/50/25.
Section 4 – Understanding Zoning
Potential High Price
$100
Sell
1/3
Top of Maybe
$70
1/4
Maybe
1/3
1/4
Top of Buy
$40
Buy
Potential Low Price
$10
1/4
1/3
1/4
3:1 UpsideDownside Ratio
$30
Section 4 – Relative Value
Once you have found a “buy”, always check
the Relative Value. We’re looking for 85-110%.
Section 4 – Relative Value (cont.)
Relative Value:
 Current P/E divided by Signature P/E
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Tells us whether we missed something
when we addressed the “quality” issues.
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Lets us know if the price is unusually high
or low. A call to investigate.
Section 5 – The Final Section
Section 5 gives us the results of our efforts;
• Total annual return, and
• Compounded annual return.
Section 5 (cont.)
Total annual return
is our estimated
growth divided over
5 years. Without the
power of compounding, we need 20% to
double our money
every 5 years.
Section 5 (cont.)
And on the other
side, we have our
compounded return.
Here, we only need
15% to double our
money every 5 years.
These are best-case scenarios!
Section 5 (cont.)
But also notice
the Projected
Annual Return.
This is our selected EPS x the
average P/E—
a more conservative compounded figure.
This is an option you must select from your
Preferences Tab in Toolkit.
Summary of Sections 3, 4 & 5
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Either eliminate outliers or cap your high P/E
at a PEG of 1.5, not to exceed 30.
Use the average 5-year low P/E, or the
lowest P/E in the most recent 5 year period.
Consider using the forward 4 quarters for
your estimated low price.
For growth stocks, use Option #1 for low
price.
Summary of Sections 3, 4 & 5
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Always set the zoning for 25/50/25 to ensure
we have a true 3:1 upside ratio.
Look for a Relative Value between 85 & 110.
And look for an compounded rate of return of
at least 15%, which will double our money
every 5 years.
(See the handout for more specifics)
The End