From: jhsu@ih-nxt03.cso.uiuc.edu (Jason Hsu)
Subject: Re: parameters to investigate in selecting a stock (LONG)
Organization: University of Illinois at Urbana
Date: Fri, 22 Jan 1993 01:34:25 GMT

In article <7423@ucsbcsl.ucsb.edu> 6500amd@ucsbuxa.ucsb.edu (Amitav Das)  
writes:
> 
> 
> To All the Guru's/semi-Guru's (Guru == expert) of the  
net.misc.invest-land:
> 
> I am not sure whether there was such a question before, but I would like  
to hear
> from you what "parameter"s you compute/watch/investigate/wink at when  
you look
> at a stock for buying? 

The Graham-and-Dodd method uses the following criteria:
1.  A price/book ratio under 2/3 -and-
2.  A debt/net worth ratio (debt meaning long-term debt and preferred 	 
	stock) under 1 -and-
3.  Either a dividend yield at least 2/3 that of the AAA corporate bond or 
	an earnings yield at least double that of the AAA corporate bond

I used these criteria for the AT&T Investment Challenge that began on  
November 2, but I had to bend the rules because I couldn't find ten true  
Graham-and-Dodd bargains.

Here are my parameters: 
> 
> Please add your own or comment on these and their merits/usefulness:

>    c. Growth rate(EPS) for last 5 years: Is it all UP UP UP UP UP? 

Growth stocks with high price/book ratios crash when earnings fall even a  
little short of lofty expectations (which is inevitable),  and get hit by  
the brunt of every bear market.  On the other hand, you do not need  
earnings growth to make a killing.  Since Nov. 2, I have made 25%  
unmargined (almost 50% with margin) in the game from Aetna Life&Casualty,  
Travelers, British Steel, Pennsylvania Central (up about 50% unmargined),  
KLM Royal Dutch, USLIFE, CIGNA, Ahmanson, Cray Research, and Kemper.  Each  
of these stocks is ahead of the market.

>    a. current PE (preferred to be less than 20, unless it has tremendous  
growth potential)

Earnings can fluctuate widely.  If the PE ratio of a value stock is low,  
great.  But if the company is losing money, a dividend can be considered a  
sign of life, because the insiders know much more than you do and have the  
right to omit the dividend if the company gets desperate. 

>    c. Compute Estimated High Price (HI) and estimated low price (LO):  
>you can get it from value line or get then my mutiplying the avg hi/lo PE  
>and projected EPS at 5 years from now.

How reliable are these figures?
>    d. Spread(SP) = HI - LO;
>    e. Buy range is bet. LO and LO+SP/3: (Cur Price should be in the  
middle of this)
>    f. Sell range is HI-SP/3 to HI
>    g. Price/Book Value (P/B) ratio: should be less than or around 3 

Good criterion, but Graham-and-Dodd want to pay much less than a dollar  
for a dollar's worth of assets.
>    h. Short position on the stock if any? 

The price/book ratio is a good popularity rating.    
>    i. Upside/Downside ratio (U/D): U/D = (HI - Cur price)/(Cur price -  
LO) indicates the risk/reward poetential of this stock, should be greater  
than 3 (so that you get better sleep at night) Any input on this?

Risk and reward potential are extremely subjective.
> 
>    j. PE/growth rate projected: For example if PE is 20 and projected  
growth rate is 20
>       and current price is 40 then EPS is 2 and in 5 years it should be  
4 and the price
>       should be 80 and you would get your money back (doubled) (assuming  
everything goes
>       properly and relative value wasless than 1). Does it make sense?  
What should be 
>       this ratio?

Good for growth investors.
> 
>    k. Any other indicators?
> 

Follow the insider crowd; insiders know much more than you do and have  
been proven to outperform the market.
> 3. GROWTH POTENTIAL
> 
>    a. Yield(Y): % of dividend as to cur price.
>    b. Growth rate of dividend over last 5 years.
> 
>        (note a & b are important if you are selecting it for "income"  
purpose, however
>         it does not hurt to get dividend from growth stocks, does it?)
> 

Good criterion.  Graham-and-Dodd stocks with earnings and dividend growth  
offer the potential to increase tenfold with no more risk than Treasury  
bills.  Unfortunately, you have to wait for a bitter cold market (like  
1974 and 1982).
>    c. Hi return (HIR): HIR = 100*(HI - Cur)/Cur + Y (should be very  
temptingly high!!!)
>    d. LO return (LIR): LIR = 100*(Cur-LO)/Cur + Y   (should not be too  
negetive)
>    e. Avg return(R)  : R   = Avg. growth rate (over last 5 years) + Y
> 
>               this should be more than 15 since I plan to at least  
double my money in
>               5 years.
> 
>      any comments on above?

Very subjective.
> 
> 4. MISC FACTORS.   So far all we have seen are only numbers and  
statistics. This is the
>    "heard in the street" or "I know since I work in the same industry"  
etc part. Its
>    hard to quantify any of these and I am just begining to get some  
sense out of my
>    observation of the market over last 6 months. Here are my (vague)  
factors:
> 
>   a. It seems to me if some analyst put it on their buy list or  
specially if they remove
>      it there is small or big jump (Market sentiment?), how can you  
perceive that in
>      advance? Should we ignore these (temorary?) fluctuations?

Look at the basic fundamentals.
> 
>   b. Market shares of the company (can be obtained from them/their  
quarterly reports)
> 
>       ... any other sources?
> 
>   c. Net profit margin (can get it from value line) but how to digest  
this data, specially
>      how can you read it? Do you compare with similar industries? Need  
input (I sound
>      like the robot in "Short Circuit" if you have seen the movie!)

They may be already reflected in the share price.
> 
>   d. Bylines from newsletter/magazines praising/hating it (But Peter  
Lynch advises to 
>      discover it before THEY do!).

If everyone touts it, be extremely skeptical.
> 
>   e. Sensing Cyclical stock before they climb up (How?)

By the Graham-and-Dodd criteria
> 
>   f. Buying before the release of their earning report is released and  
getting some
>      prediction from analysts/company (I wish I could have done it for  
Intel!)?

Risky, involves active trading, and too many Maalox moments.
> 
>   g. WSJ runs some nice articles about companies, their new/future  
products sometime
>      on a particular product(group) and what company has what market  
share.

If everyone touts it, be skeptical.



Oops, I just read that this was to be e-mailed.