Developing the Story of a Company

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Developing The Story

By Kevin Gillogly

HDIC Education Segment

April 2004

Part I


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Understanding The CompanyBy asking some basic

questions aboutcompanies, you canlearn which are likely

to grow and prosper,which are unlikely togrow and prosper, andwhich are entirely

mysterious,Peter Lynch, One Up On

Wall Street, Pg. 74.


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Investing without research is likeplaying stud poker and never

looking at the cards All you haveto do is put as much effort intopicking your stocks as you do in

buying your groceries.

Peter Lynch, One Up OnWall Street, pg. 107


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The drive of a corporationsmanagement is the singlemost influential element ofgrowth.

-- NAIC OfficialGuide, pg. 21


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However, a stock has come to yourattention What youve got so far is simply

a lead to a story that has to be developedDeveloping the story is really not difficult:at most it will take a couple of hours Itseems to me that this homework phase is

just as important to your success in stocks.



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Gather Data

About the company

About its competitors

Organize InformationOn the SSG & SCG

Apply common sense

JudgmentPractice and more

practice!


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Gathering the Data

Use at least three sources

Value Line &/ or S&P tearsheets Great for both company and industry data

Current news from the internet

Yahoo or MSN are the easiest to use

Company itself Best source of data even after the

Enrons and World Coms

Read the Annual Report, esp. MD&A, &other company news releases.


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Developing The Story1. Understand the economy

Where are we in the economic cycle?

How does that impact this industry?

Can be done in less than two minutes.

2. Understand the industry What is the long-term direction of this

industry? Demographics

Competition

Can be done in less than fifteen

minutes.


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Developing The Story3. Understand the company

How do they make their money?

What is the competition like?

What are the strengths & weaknessesof the company / industry?

What are the threats & opportunities of

the company / industry? Can be done in around sixty minutes.


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Stages of Growth

Break Even Point

Explosive

Growth

Startup

Matu

reGr

owth

Stabilization

enil

ceD

Best

Investment

Opportunity

Speculation

Life Cycle ofA Successful

Company

No dividends

Small dividends

(Payout ratio 35%)


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Stages of Growth The more you understand:

Type of company you are looking

Fast growth or steady grower

Slow growth or turnaround Cyclical or asset play

Its business model How it makes money

Who is its competitors? Threats it faces; Opportunities it has

Strengths it has; Weaknesses it has

Then the better your chance to select

realistic future P/Es.


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Peter Lynchs

Stages of Growth Fast growth companies

May grow at over 20% per year Have SSG graphs that look like

summit of a mountain peak

Walgreens, Lincare, Renal Care Group

The trick is figuring out whentheyll stop growing, and how muchto pay for the growth. Peter Lynch


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Peter Lynchs

Stages of Growth Steady growth companies

(stalwarts) Look for 10-12% growth per year Have SSG graphs that look like the

foothills of mountains Coca-Cola, Johnson & Johnson, AFLAC


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Peter Lynchs

Stages of Growth Slow growers

Tend to grow less than 6% per year

Have SSG graphs that look like the state

of Delaware flat Clorox, Proctor & Gamble

Usually large and aging companies areexpected to grow slightly faster than the

gross national product (3%). P. Lynch Cyclicals

Have SSG Graphs that look like thepolygraphs of liars Ford, GM, Boeing


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4.Only after looking at the bigpicture can you begin to evaluate

future growth and future P/E inSection 3 of the SSG.


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5. Look at the 5 year trends

Growth comes future EPS

Management is the key Value comes from making educated

guesses about future P/Es.

Never want to over pay for growth

NAIC investors look for growthcompanies that are on sale

GARP Growth At a Reasonable Price


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5. Look at the 5 year trends

Where is the P/E in relation to its

history? Are the trends for high and low P/E down?

up? Or both?

Give greater weight to recent events

Compare to P/Es of the general market Compare to P/Es for its chief

competitors


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Companies with long recordsof above average growth tend to

sell at higher P/Es, but theirhighs are usually not

sustainable.

-- Handbook, 130


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Wall Street does not look kindlyon fast growers that run out of

stamina and turn into slowgrowers, and when that happens,the stocks are beaten down

accordingly.

-- Peter Lynch,

One Up On Wall Street,

pgs. 118-119


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When the growth stops When growth stops, Round I EPS will slow down

Price will drop faster than EPSbecause investors wont pay apremium for slower growth

Causing P/E contraction

When the growth stops, Round II Which can feed more price dropping

Which can cause more P/Econtraction


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ReviewAs soon as sales and/or EPS falter, growing

stocks often react as if their growth vehicle hita brick wall... Sometimes longstanding growthcompanies with previously high ratings slowdown and the price can fall by 50 percent.They are often referred to as fallen angelsthey pass our SSG test as if they were thegreatest buys in the world (except that the

most recent quarterly figures will be down).Many of those fallen companies recover andcontinue to new highs, but others cease to begrowth companies.

-- Ed Chiampi BI, April 98


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Review A companys growth prospects and

P/Es are NOT determined in a vacuum.

Understand the companys businessmodel

Understand what the competition is doing

What are its strengths and weaknesses?

What are its opportunities and threats?

Understanding what a company doeswill help make your projections moreaccurate


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Once youre able to tell the storyof a stock to your family, your

friends, or the dog so that even achild could understand it, then youhave a proper grasp of the

situation.



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Questions

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Developing the Story of a Company