Stock Picking Strategy

**JimBob2232** Sat Feb 18, 2006 1:47 pm

Stock Picking Strategy
I am trying to do some research into stock picking strategies. I am starting a blog on this one to track it and see what i learn. I am not necessarily investing in any of these companies, but more than anything hope to learn a little more about the market by doing so. Perhaps some of you can help me learn a bit and benefit yourself as well.

The blog is here (http://valueinvestmenting.blogspot.com/) yeah, i cant spell...what the heck is valueinvestmenting...but I dont feel like changing it, so deal.

Basically the strategy is to invest in only S&P 500 stocks. My reason for this, is that these are the 500 companies who get the most focus, and are most likely to correct themselves quickly. Its also harder to find undervalued stocks in this group for the same reason.

So I took the 500 S&P 500 stocks, found high and low P/E over a 5 year period for each stock.

I then looked at analyst estimates for earnings. Most S&P 500 stocks are covered by many analysts, which is another bonus of using only S&P 500 stocks. I assume analysts can project earnings better than I can.

I gathered Hi/Low/Average stock earnings estimates for 2006 and 2007 for each S&P 500 stock.

Now it was calculation time. Using the Low 5 year P/E and the average earning estimates for 2006 and 2007, I calculated the projected future stock price for the end of 2006 and 2007. I also did the same calculation using the lowest analyst earnings estimate with the lowest 5 year P/E to calculate the "maximum downside"

I then screened out only those stocks who were trading 5% or more below the avg analyst 2006 estimate * low 5 year P/E.

From there, I screened out any company with declining earnings from 2006-2007. One company due to an ongoing SEC investigation, a few companies with Debt to Equity ratio greater than one, and a few companies who would not meet the criteria above if their P/E fell to 20, which i deemed too high, even though it was below their 5 year low P/E.

So that left me with 17 companies. 14 of which I am quite familiar with, and feel are good sound companies. And 4 companies, I am unfamiliar with (BSX, PMTC, PPG and UNM).

So I have set up a model portfolio on my yahoo account to track the progress and see if this model works. It seems pretty foolproof to me...but then again, if it was so foolproof, why am I the one who came up with it?

Of the 13 companies I decided to use to set up my model portfolio, 11 of them have so called "gurus" invested in them. This leads me to believe even more that there may be something good to this rather simple and rudementary approach.

The results:

Company, Ticker, Current Price, 1year Target, 2 year Target
Symantec, SYMC, 17.52, 23.96, 27.59
Xerox, XRX, 14.76, 18.72, 20.88
WalMart, WMT, 46.10, 55.54, 63.18
Locheed Martin, LMT, 72.84, 87.11, 93.33
Pfizer, PFE, 25.82, 29.75, 31.38
Tyco, TYC, 25.85, 29.10, 32.91
Molex, MOLX, 32.56, 35.69, 42.43
Raytheon, RTN, 43.02, 46.67, 53.80
Johnson and Johnson, JNJ, 59.07, 63.66, 69.72
Oracle, ORCL, 12.4, 13.18, 15.55
IBM, IBM, 80.71, 85.41, 93.35
Microsoft, MSFT, 26.7, 28.12, 32.59
Coke, KO, 41.79, 43.97, 47.81

It looks like this portfolio should earn a MINIMUM of 14% a year, assuming all companies meet earnings estimates.

Thoughts?

JT Sat Feb 18, 2006 10:35 pm

Re: Stock Picking Strategy
"It looks like this portfolio should earn a MINIMUM of 14% a year, assuming all companies meet earnings estimates."

The question is this, how do you know the future revenue/earnings growth will match that of the past? Growing from $100B to $200B is not the same as growing from $1B to $2B.

Sometimes I ask myself these questions, "Do I have an idea how much revenue this company can generate in the future?" "How do I arrive at those revenue and earnings numbers?" "Are those numbers realistic?"

Also, meeting the earnings numbers doesn't necessarily mean PE will not contract.

**JimBob2232** Sun Feb 19, 2006 10:09 am

Undertsood. There is a point where you start seeing diminishing returns on your investment. In this strategy, I am not (i dont think) basing my future earnings on past earnings. Instead I am relying on analyst projections for future earnings. Even more importantly, I am relying on average earnings (I'd use median earnings, but I dont know where to get that data). I even use the lowest analysts earnings projection combined with average 5 year P/E, which in all cases in this portfolio resulted in stocks with a higher stock price then they are currently trading at (granted most are marginal 2-3% gains).

So no, "I" do not have an idea how much revenue they can gain in the future. I have a very specific skill set, that is largely unrelated to investing. But I am assuming the analysts have a pretty good idea of how much a comany will earn. Moreso, I am making the return OF my money a near certainty unless ALL analysts are wrong.

Yes, the P/E could contract. Thats why I am using 5 year Low P/E for my decision. Could it go lower than that? Sure. Perhaps I should put a margin of safety on my P/E, even lower than the 5 year low to help in this regard.

Thanks for your comments. Please dont read my above comments as me trying to blindly prove my method works, because "I" am trying to see if it works, and learn a little in the process.

Again, Thanks.

**blast_investor** Mon Feb 20, 2006 6:26 pm

Hi JimBob2232:

Your screening method sounds like a method called "relative value method" that many gurus in mutual funds world are using.

Basically, the idea is to look at valuation range for past several years, or even decades on a stock in big cap world, and find the lowest PE in that period. When a stock hit PE in the low band of historically range, buy it and hope the stock will trade to mid-range or upper band of valuation.

This "relative value method" is valid value investing approach for big cap stocks because most of them have stable business to make the assumption intact. This method makes sense.

That is probably the reason why you see lots of gurus in the stocks you found.

On the other hand, whether your screening approach can achieve '14%' return is questionable. You would have to do a comprehensive data mining effort to simulate back several decades with your screening method to find out the potential reward. Also, you can not really trust Wall Street analysts estimate either. They typically are short-sighted and they only look ahead several quarters. They do not know a business several years ahead.

One major danger in this method is the blind trust on the "historical valuation range of a certain stock". We typically do not trust that in our practise because historical valuation range could be over-priced or under-priced for years or a decade. In fact, we believe the S&P500 valuation is not very cheap based on our future earning assessment. Therefore, we are on slightly bearish side on the whole S&P500 index.

**blast_investor** Mon Feb 20, 2006 6:32 pm

Quote: "ALL analysts are wrong".

I do not know when "all analysts are correct". Analysts are behaving like a herd. They do not want to stand outside of their peers for various reasons.

Wall Street analysts estimate is not a reliable sources. Sometimes they are right, sometimes they are wrong. Their analysis mostly is "garbage in and garbage out" style.