Investment Strategy IIEconomics 98 / 198 DeCal Fall 2007

Lecture 7

Announcements

• Homework due next week• Also, attach trading history to your paper

Current Events

Lecture Content

Last Week

• Introduction to investment strategies• Qualitative vs. Quantitative Analysis• Fundamental vs. Technical Analysis

• Value vs. Growth Investing

• Fundamental Analysis• Qualitative Aspects (Understanding the business,

competitive advantages, industry, management, etc.)

• Value Investing • Buying stocks that are valued below its intrinsic value• Using various financial ratios and measures

Today

• Growth Investing

• CAN SLIM• C = Current Quarterly Earnings per share• A = Annual Earnings Increases• N = New Products, Managements, Highs• S = Supply and Demand• L = Leader or Laggard• I = Institutional Sponsorship• M = Market Direction

GROWTH INVESTING

Growth Investing

• Buy stocks that expected to grow quickly in sales and earnings (relative to industry and market)

• Underlying quality of the business and the rate at which it is growing • Usually newer companies, industries, and

markets• Will usually have a higher P/E. Why?

Growth Investing

• No automatic formula for determining best growth stocks

• General guidelines• Strong historical earnings growth • Strong forward earnings growth• Management control of costs and revenues• Company efficiency• Innovative products / industry

CAN SLIMINVESTING

CAN SLIM Background

• Developed by William O’Neil

• Developed from studies on greatest stock winners of all time

• Provides solid guidelines to prevent subjectivity• Combination of growth, fundamental,

technical analysis

CAN SLIM Performance 1998 - 2005

28.60%

860.30%

CAN SLIM S&P 500

Source: American Association of Individual Investors

C = Current Quarterly EPS

• Bottom line counts - major % increase in current quarter EPS (25% or more)

• Look for accelerating growth• What does this mean?

• Should be supported by sales growth (revenue) – Why?

C = Current Quarterly EPSExamples

• Cisco Systems – EPS gains of 150% and 155% in 2 quarters prior to 1467% run-up over next three years

• AOL – EPS gains of 900% and 283% before rising 557% in 6 months

• Dell – 74% and 108% before rising 1780% in 27 months in November 1996

Resource for Quarterly Earnings: MSN Money

Revenue Figures (Calculate growth rates yourself)

EPS Growth Rates (Year over Year)(Eg. Q1 ‘04 vs Q1 ‘05)

A = Annual Earnings

• Annual earnings growth 25% or more over past 3 – 5 years• ROE at least 17% or higher

As O’Neil says, "who wants to own part of an establishment showing no growth"?

Why is annual growth vs. quarterly growth important?

A = Annual EarningsExample

Xerox• earnings growth rate 32% before

soaring 700% in 1963-1966

Wal-Mart• 43% annual EPS growth before

rocketing 11,200% from 1977 to 1990

Cisco (257%) and Microsoft (99%)

Resource for Quarterly Earnings: MSN Money

Annual Earnings Per

Share

N = New products, management, highs

• Takes something new to produce startling advances in price of stock (ideas, products, services, etc.)

• Apple • Abercrombie• Cisco• Charles Schwab• Taser• Sunpower

N = New products, management, highs

• Buy stocks when emerge from consolidations patterns and make new highs (technical analysis)

“Buy low, sell high”

vs.

“Buy high, sell higher”

S = Supply and Demand

• Law of supply and demand determines price of almost everything

This is where technical analysis comes into play

Want to buy stocks that are being bought by institutions (importance of volume)

L = Leader or Laggard

• Narrow down selection to best industries / sectors of stock market• Narrow further by selecting best

companies in the industry

• Best doesn’t meanthe biggest or most well-known

L = Leader or Laggard

• New leaders every cycle• 1999-2000 Tech, Telecom• 2002-2004 Real Estate, Energy, Retail• 2004-Present Foreign, ???

• Look for companies that withstand downturns in market the best

• What does this mean?

• Criteria: • Earnings / sales growth, ROE, margins, etc.

A Tool for Industry Research / Rankings: Stockcharts.com Industry Tool<http://stockcharts.com/charts/performance/perf.html?$BKX,$XAU,$SOX,$OSX,$DRG,$GSPMS,$DOT,$BTK,$XBD>

A Tool for Industry Research / Rankings: Investor’s Business Daily

A Tool for Industry Research / Rankings: www.prophet.net

Rank Industries by Performance

over Various Periods

Click on the chart box to get charts for all companies

within the industry

I = Institutional Sponsorship

• Want to own stocks significantly owned by top institutions• Institutions: mutual funds, pension funds,

hedge funds, banks, universities• Can account for up to 70% of trading

activity

I = Institutional Sponsorship

Institutional Investors

- Mutual Funds

- Hedge Funds

- Pension Funds

- Educational

Institutions

- Bank Trusts

Individual Investors

- You

- Me

- Parents

- Uncle Joe

A Tool for Institutional Sponsorship: MSN Money (http://moneycentral.msn.com/ownership)

Mutual Fund Ownership

Ownership Activity

Specific Mutual Funds

Ownership (with links to fund

quotes)

• You can be right about everything, but if you’re wrong about where market is heading…

Why?

M = Market Direction

M = Market Direction

• Importance of following the market• It can be done! (Next lecture)• Bull market vs. Bear market

• Myth of Long-Term “Buy-and-hold” Investing

• 33% loss requires 50% gain to break even• 50% loss requires 100% gain to break even

M = Market Direction

• Stay out in cash during bear markets and invest during bull markets

• Don’t try to anticipate the market (gambling)

• Instead, let market guide you

• How to do this? (next lecture)

CAN SLIM Overall Strategy

• Narrow your selection (watch list) of stocks through fundamental analysis• Use technical analysis (charts) to

determine when to buy into stock and sell out

• Don’t buy stock just b/c of low price• You don’t make money on how many shares you

own, but by how much money is invested

• Do not let small losses turn into large ones (cut losses early)

Homework / Reading

• Paper: Complete by next week

• Reading:• Investopedia. Introduction to Support &

Resistance