EWHieeeOrg R1 Berkshire Notices InvestmentStrategyForEngineersNovember192010

Investment Strategy for

Engineers

October 10, 2003 1Roger Manzolini

Investment Strategy for

Engineers

Money and Investing

� Investment Strategy for Engineers

Roger Manzolini


Roger Manzolini

November, 2010

� This presentation is the creation of Roger Manzolini and is to be used for informational use only

� Roger is not a certified financial planner nor a financial advisor of any kind, so use of this

Disclaimer


financial advisor of any kind, so use of this information is at your own risk

� None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security

Additional caution: My peers call me Maddog

� Introduction

� Capital Market Characteristics

� Composition

� Asset Classes

Performance

Portfolio Strategy Topics


� Performance� Risk and Return

� “Ideal” Portfolio

� Stock Selection

� Financial Ratios

� 10 Things to Know

� Sales people at the local computer store can’t answer any of your questions� You’ve already calculated how much you make per second� You look forward to Christmas so you can put the kid’s toys together� You have saved every power cord from every broken appliance� You still own a slide rule and know how to use it� You’ve tried to repair a $5.00 radio� You window shop at Radio Shack

Characteristics of an EngineerPer ‘Google’ search


You window shop at Radio Shack� At an air show, you know how fast the skydivers are falling� You see a good design, and have to change it� You take a cruise so you can go on a personal tour of the engine room� You know what http:// stands for� You spent more on your calculator than you did on your wedding ring� You comment to your wife that her straight hair is nice and parallel� Your spouse doesn’t have the foggiest idea of what you do at work� You think that people yawning around you are sleep deprived

I paid $8

� Like manipulating numbers� Like doing things yourself� Creatures of habit; pretty much the same routine every day

� Work, work, work, no time to relax or play� Don’t plan week-ends or vacations� Not able to dress themselves� Show limited interest in others, especially non-contributors

Characteristics of an EngineerAs observed by Roger


Show limited interest in others, especially non-contributors� Tend to dislike managers� Tend to repeat themselves� Very interested in how things work� Very conservative� Not particularly interested in money� Don’t like to spend money� Reluctantly trusting – verify everything� Generally not active traders� More buy and hold type of investors

� Goals need to be established by each individual

� I geared this presentation towards a ‘typical’ conservative engineer

� I assumed the most prevalent goal of:

� Financial success in the stock market; that is:

� Consistent, market-beating returns

� Do better than the general market (10-12% annually)

IntroductionFitting the strategy to the audience


� Do better than the general market (10-12% annually)

� Improve your return year over year

� Do better each year

� Keep losses (trade) small

� Less than 1-2% of total portfolio

IntroductionCompound Interest

� Exactly what Einstein said (or even if he said anything at all) about compound interest varies quite a bit from source to source. He allegedly said that compound interest was:

� “the greatest invention in human history”

� “the greatest invention of mankind”

� “the greatest invention of all”

� “the most significant invention of the 19th century”

480 0.055 0.116

0.004583333 0.009666667

480 174,103.96$ 1,037,198.97$

6


� “the most significant invention of the 19th century”

� “the most powerful force in the universe”

� Whatever he allegedly said, the message is clear; the power of compound interest is strong and cannot be overlooked. E.g.

� Saving $100/month for 40 years @ 5.5% grows to ~$174K

� Saving $100/month for 40 years @ 11.6% grows to ~$1M

~Twice the interest …..~Six times the result

Early Saver Late Saver($5k for 10 years; age 22-31) ($10k for 25 years; age 41-65)

age 8.00% 8.00%

save interest total save interest total

22 $5,000 $0

23 $5,000 $0

24 $5,000 $0

25 $5,000 $0

26 $5,000 $0

27 $5,000 $0

28 $5,000 $0

29 $5,000 $0

30 $5,000 $0

31 $5,000 $0

32 $0 $0

33 $0 $0

34 $0 $0

35 $0 $0

36 $0 $0

37 $0 $0

38 $0 $0

39 $0 $0

40 $0 $0

41 $0 $10,000

42 $0 $10,000

Money and

Investing42 $0 $10,000

43 $0 $10,000

44 $0 $10,000

45 $0 $10,000

46 $0 $10,000

47 $0 $10,000

48 $0 $10,000

49 $0 $10,000

50 $0 $10,000

51 $0 $10,000

52 $0 $10,000

53 $0 $10,000

54 $0 $10,000

55 $0 $10,000

56 $0 $10,000

57 $0 $10,000

58 $0 $10,000

59 $0 $10,000

60 $0 $10,000

61 $0 $10,000

62 $0 $10,000

63 $0 $10,000

64 $0 $10,000

65 $0 $10,000

$50,000 $250,000

Late saver contributes 5 times as much

Early Savings Lesson

Money and

Investing

Early Saver Late Saver($5k for 10 years; age 22-31) ($10k for 25 years; age 41-65)

age 8.00% 8.00%

save interest total save interest total

22 $5,000 $400 $5,400 $0 $0 $0

23 $5,000 $832 $11,232 $0 $0 $0

24 $5,000 $1,299 $17,531 $0 $0 $0

25 $5,000 $1,802 $24,333 $0 $0 $0

26 $5,000 $2,347 $31,680 $0 $0 $0

27 $5,000 $2,934 $39,614 $0 $0 $0

28 $5,000 $3,569 $48,183 $0 $0 $0

29 $5,000 $4,255 $57,438 $0 $0 $0

30 $5,000 $4,995 $67,433 $0 $0 $0

31 $5,000 $5,795 $78,227 $0 $0 $0

32 $0 $6,258 $84,486 $0 $0 $0

33 $0 $6,759 $91,244 $0 $0 $0

34 $0 $7,300 $98,544 $0 $0 $0

35 $0 $7,884 $106,428 $0 $0 $0

36 $0 $8,514 $114,942 $0 $0 $0

37 $0 $9,195 $124,137 $0 $0 $0

38 $0 $9,931 $134,068 $0 $0 $0

39 $0 $10,725 $144,794 $0 $0 $0

40 $0 $11,583 $156,377 $0 $0 $0

41 $0 $12,510 $168,887 15.64 $10,000 $800 $10,800

42 $0 $13,511 $182,398 8.12 $10,000 $1,664 $22,464

Early Savings Lesson

42 $0 $13,511 $182,398 8.12 $10,000 $1,664 $22,464

43 $0 $14,592 $196,990 5.62 $10,000 $2,597 $35,061

44 $0 $15,759 $212,749 4.37 $10,000 $3,605 $48,666

45 $0 $17,020 $229,769 3.63 $10,000 $4,693 $63,359

46 $0 $18,382 $248,151 3.13 $10,000 $5,869 $79,228

47 $0 $19,852 $268,003 2.78 $10,000 $7,138 $96,366

48 $0 $21,440 $289,443 2.52 $10,000 $8,509 $114,876

49 $0 $23,155 $312,598 2.32 $10,000 $9,990 $134,866

50 $0 $25,008 $337,606 2.16 $10,000 $11,589 $156,455

51 $0 $27,008 $364,615 2.03 $10,000 $13,316 $179,771

52 $0 $29,169 $393,784 1.92 $10,000 $15,182 $204,953

53 $0 $31,503 $425,287 1.83 $10,000 $17,196 $232,149

54 $0 $34,023 $459,310 1.76 $10,000 $19,372 $261,521

55 $0 $36,745 $496,054 1.69 $10,000 $21,722 $293,243

56 $0 $39,684 $535,739 1.64 $10,000 $24,259 $327,502

57 $0 $42,859 $578,598 1.59 $10,000 $27,000 $364,502

58 $0 $46,288 $624,886 1.54 $10,000 $29,960 $404,463

59 $0 $49,991 $674,876 1.51 $10,000 $33,157 $447,620

60 $0 $53,990 $728,867 1.47 $10,000 $36,610 $494,229

61 $0 $58,309 $787,176 1.45 $10,000 $40,338 $544,568

62 $0 $62,974 $850,150 1.42 $10,000 $44,365 $598,933

63 $0 $68,012 $918,162 1.40 $10,000 $48,715 $657,648

64 $0 $73,453 $991,615 1.38 $10,000 $53,412 $721,059

65 $0 $79,329 $1,070,944 1.36 $10,000 $58,485 $789,544

$50,000 $1,020,944 $1,070,944 $250,000 $539,544 $789,544

Early saver accumulates 35% more

IntroductionStart Early

ReturnEarly Saver

invested $50k

Late Saver

invested $250k

Difference

in accounts

2% $109,491 $326,709 ($217,218)

4% $236,886 $433,117 ($196,231)

What about at different interest rates?


Clue: Time and Rate of Return is critical.Small bits of return can make a huge difference

4% $236,886 $433,117 ($196,231)

6% $506,544 $581,564 ($75,020)

8% $1,070,944 $789,544 $281,400

10% $2,239,402 $1,081,818 $1,157,584

12% $4,632,883 $1,593,339 $3,039,544

Options used to generate moneyHigh risk/high return (30% or more)

10% but not morethan $30K

MoneyEngine

Portion of moneyto be managed

IntroductionHigh Level Strategic View


Stocks / Bonds used to grow moneyModerate risk/moderate return (8-12%)

CDs / Treasury Bills used topreserve / protect money (1-5%)

75-50%Investment

Portfolio

Savings Portfolio15-40%

Introduction Savings Portfolio

� Savings Portfolio Strategy

� Establish a ladder of CDs and Treasury Bills

� Generally longer term certificates or T-Bills pay

Dividend as of

11/17/20101.04% 1.54% 1.88% 2.23% 2.57%

multiplier 1.5 1.8 2.1 2.5

1-yr CD 2-yr CD 3-yr CD 4-yr CD 5-yr CD

year 1

Buy 1-yr, 2-yr,

3-yr, 4-yr, and

5-yr CDs

1 1 1 1 1

year 2Roll 1yr CD

into 5yr CD1 1 1 2


certificates or T-Bills pay higher premiums.

� Give up some liquidity for 2.5 times the premium

into 5yr CD

year 3Roll 2yr CD

into 5yr CD1 1 3

year 4Roll 3yr CD

into 5yr CD1 4

year 5Roll 4yr CD

into 5yr CD5

year 6

and all

subsequent

years

Roll 5yr CD

into 5yr CD5

� Stock Market

� 12 Sectors� Basic Materials, Capital Goods, Conglomerates, Consumer Cyclical,

Consumer/Non-Cyclical, Energy, Financial, Healthcare, Services, Technology, Transportation, Utilities

� Each sector is comprised of a number of industries

� 102 industries

Capital Market CharacteristicsMarket Composition


� 102 industries� E.g. the Technology sector is comprised of 11 industries

� Communications Equipment, Computer Hardware, Computer Networks, Computer Peripherals, Computer Services, Computer Storage Devices, Electronic Instr. & Controls, Office Equipment, Scientific & Technical Instr., Semiconductors, Software & Programming

� Each industry is comprised of a number of stocks

� ~14,000 stocks� E.g. the Computer Hardware industry is comprised of 34 stocks


12 Sectors

Basi

c

Mate

rials

Capit

al

Goods

Conglo

mera

tes

Consu

mer

Cyc

lica

ls

Consu

mer

Non-C

yclica

ls

Energ

y

Financi

al

Healt

hca

re

Serv

ices

Tech

nolo

gy

Tra

nsp

ort

ati

on

Uti

liti

es

102 Industries 11 7 1 12 8 4 10 4 25 11 6 3

14,387 Stocks 2,032 635 90 479 406 1,054 3,674 1,243 2,296 1,990 226 262

1 207 105 90 70 37 57 122 708 78 224 11 164

2 26 37 28 49 83 23 158 101 34 43 71

3 62 84 45 27 712 52 33 369 38 48 27

4 23 42 44 15 202 22 344 76 49 20

5 23 159 91 175 127 296 347 38

6 1,045 197 25 12 183 38 28 66


6 1,045 197 25 12 183 38 28 66

7 48 11 43 79 2,252 66 266

8 384 15 12 43 49 17

9 81 12 649 75 129

10 92 83 201 19 272

11 41 15 345 586

12 8 57

13 41

14 102

15 65

16 46

17 33

18 26

19 50

20 11

21 119

22 16

23 62

24 57

25 99

# S

tock

s in

each

Indust

ry

1. Basic Materials 11 2,0322. Capital Goods 7 6353. Conglomerates 1 904. Consumer Cyclical 12 479

12 Sectors 102 Industries 14,387 Stocks



4. Consumer Cyclical 12 4795. Consumer/Non-Cyclical 8 4066. Energy 4 1,0547. Financial 10 3,6748. Healthcare 4 1,2439. Services 25 2,29610. Technology 11 1,99011. Transportation 6 22612. Utilities 3 262

1. Apple Inc.2. Agilysys, Inc.3. Asiarim Corp4. Boundless Corp5. Softchoice Corp.6. Canadian Energy Exploration

Inc (Tier2)

18. Metro One Dev Inc New19. Insight Enterprises, Inc.20. Radisys Corporation21. Socket Mobile, Inc.22. Steelcloud Inc23. Sed Intl Holdings Inc24. Secure Netwerks Inc

� The 34 stocks in the Computer Hardware industry



Inc (Tier2)7. Intensity Company Inc8. Concurrent Computer

Corporation9. Cray Inc10. Dell Inc.11. Digi International Inc.12. Global E-Point Inc13. Gtsi Corp.14. Hewlett-Packard Co15. Ingram Micro Inc.16. Intermec Inc17. Lenovo Group Ltd S/Adr

24. Secure Netwerks Inc25. Silicon Graphics International

Corp26. Silicon Mtn Holdings Inc27. Super Micro Computer, Inc.28. Softnet Tech Corp29. Speaking Roses Intl Inc30. Tech Data Corporation31. Televideo Inc32. Transnet Corp33. Voltaire Ltd.34. Wareforce .Com Inc

� Asset Allocation (e.g., large-cap, small-cap, bonds, …)

� Asset class diversification will have the largest positive impact on your portfolio return

� The trade-off between Return and Risk

� Performance and risk are positively intertwined

� Small changes in these percentages have “huge”

Capital Market CharacteristicsKey points


� Small changes in these percentages have “huge” consequences

� Long term

� Long term investing is pertinent to both total return and risk reduction

� Investment style (e.g., growth, income, …)

� Investment style diversification positively impacts your portfolio return

� Investment choices fall into three main categories called asset classes

� Short-term investments or money market funds

� Also referred to as “Cash & cash equivalent” assets

� Fixed Income

Capital Market CharacteristicsAsset Classes


� Fixed Income� Loosely referred to as “Bond” or “Fixed income” assets

� Equity� Loosely referred to as “Stock” or “Equity” assets

� Cash & cash equivalents

� Fixed income

� Taxable bonds

� Tax-exempt bonds

� Equity

� Balanced

Capital Market CharacteristicsMore on Asset Classes


� Balanced

� Large-cap Value

� Large-cap Growth

� Mid-cap

� Small-cap

� Diversified

� Global

� International

� Any short term liquid asset

� Cash

� Savings & checking accounts

� Certificates of deposit

� Money markets funds (e.g.stable value fund)

Capital Market CharacteristicsCash & Cash Equivalents


� Money markets funds (e.g.stable value fund)

� Not included in most long term portfolios

� The idea of investing is to exceed the market risk rate of return, the short term treasury rate of return generally considered to be ~ 5%� Exceeds typical C&CE returns

� Taxable bonds

�Short term bonds

� Long term bonds

�Bond funds

Capital Market CharacteristicsFixed Income


�Bond funds

� Tax-exempt bonds

�Municipal bonds

�….

� A type of fund that pursues a hybrid investing strategy in order to offer investors both capital appreciation and income generation. Balanced funds contain a mix of:

� Stocks,

� Bonds

Capital Market CharacteristicsBalanced Equity


� Bonds

� other types of securities.

My take is to avoid these types of funds:

-You don’t control mix-Typically excessive fee

� Large-Cap - Stocks of companies with a market capitalization >$5B

� Traded ‘mostly’ on the NYSE

� Lowest risk; lowest return (potential)

� Mid-Cap - Stocks of companies with market capitalization

Capital Market CharacteristicsLarge-Cap, Mid-Cap, Small-Cap


� Mid-Cap - Stocks of companies with market capitalization between $500M and $5B

� Traded on both the NYSE and NASDAQ

� moderate risk; moderate return (potential)

� Small-Cap - Stocks of companies with a market capitalization < $500M

� Traded ‘mostly’ on the NASDAQ

� highest risk; highest return (potential)

� Stocks of companies with a market capitalization greater than $5 billion that:

� Trade at discounts to book value or tangible book value

� Have high dividend yields

� Have low price-to-earning multiples or

Capital Market CharacteristicsLarge-Cap Value


� Have low price-to-earning multiples or

� Have low price-to-book ratios

My take is to avoid specific value funds but to use an index fund instead:

-Spreads risk (diversification)-Reduces fee

� Book value is often synonymous with the net value

� Book value = Assets – Liabilities, where:� Assets include

� Tangible assets� Owned property, product inventory, cash reserves, receivables and

investments

Capital Market CharacteristicsBook value and tangible book value


investments

� Intangible assets� Patents, trademarks, copyrights, and future earnings potential or

expected returns

� Tangible book value� Book value where assets include only tangible assets

� Always less than book value

� A more conservative estimate of net value

Capital Market CharacteristicsLarge-Cap Growth

� Stocks of companies with a market capitalization greater than $5 billion that:

� Have historically achieved measurable growth traits, particularly characterized by:

� Strong earnings growth and


� Strong earnings growth and

� High profitability ratios. .

My take is to avoid specific growth funds but to use an index fund instead:


� An investment fund that contains a wide array of securities to reduce the amount of risk in the fund

� A diversified fund contrasts with specialized or focused funds, such as sector funds, which focus on stocks in specific sectors such as biotechnology, pharmaceuticals

Capital Market CharacteristicsDiversified


specific sectors such as biotechnology, pharmaceuticals or utilities, or in particular regions such as Asia or Europe

� Maintaining diversification

� Prevents events that affect one sector from affecting an entire portfolio

� Makes large losses less likely

� Global - A fund (typically a mutual fund) that invests in companies located:

� Anywhere in the world

� International - A fund (typically a mutual fund) that invests in companies located:

Capital Market CharacteristicsGlobal, International


in companies located:

� Anywhere outside of its investors' country of residence

My take is to avoid specific Global or International funds but to use a Global or International ETF (index) instead:


� Returns based on historical results are useful for learning and demonstrating strategy

� Historically, each asset class has produced

Capital Market CharacteristicsPerformance Expectations


� Historically, each asset class has produced different returns and risks associated with those returns�Each class can be loosely tied to a particular

investment objective

Return Return

1927-1969 1970-2002Asset Class

Capital Market CharacteristicsPerformance Data – Example


U.S. large growth stocks 9.3% 10.7%

U.S. large value stocks 11.1 13.9

U.S. small growth stocks 10.9 11.7

U.S. small value stocks 13.4 15.5

Fixed Income Assets 1964-2002

10

12

14

16

18

An

nu

al R

etu

rnCapital Market CharacteristicsReturn vs. Risk

Note: Risk can be

Return Volatility

One-month T-Bills 6.2 1.3

Six-month Rolling T-Bills 7.0 1.7

One-Year Rolling T-Bills 7.2 2.3

Five-Year T-Notes 7.8 6.4

20-Year Govt. Bonds 7.7 11.1


0

2

4

6

8

10

0 5 10 15 20 25

Volatility (Standard Deviation)

An

nu

al R

etu

rn

Note: Risk can be managed by avoiding longer term fixed assets

Capital Market CharacteristicsReturn vs. Risk

Risk and Return over 70 Years (1931-2000)

1012141618

An

nu

al R

etu

rn

Return Volatility

US Treasury Bills 3.9 3.3

Long Term US Bonds 5.6 9.3

Large-Cap Stocks 11.0 19.3


02468

10

0 5 10 15 20 25


An

nu

al R

etu

rn

Capital Market CharacteristicsReturn vs. Risk

Risk and Return over 25 Years (1976-2000)

12

14

16

18

An

nu

al R

etu

rn

Note: Higher returns

Return Volatility

US Treasury Bills 7.0 2.9

Long Term US Bonds 10.1 10.8

International Stocks 13.6 19.1

Large-Cap Stocks 15.3 17.2

Small-Cap Stocks 16.2 24.1


0

2

4

6

8

10

0 5 10 15 20 25


An

nu

al R

etu

rn

Note: Higher returns only come at the cost of increased risk

Capital Market CharacteristicsReturn and Risk relationship

� Risk is an important factor in determining how to effectively manage a portfolio of investments. Risk:

� Determines the variation in returns on the asset and/or portfolio

� Provides investors a mathematical basis for investment decisions (known as mean-variance optimization).

� The overall concept of risk is:


� The overall concept of risk is:

� That as it increases, the expected return on the asset will increase as a result of the risk premium earned i.e.,

� investors should expect a higher return on an investment when that investment carries a higher level of risk, or uncertainty of that return

� When evaluating investments, investors should estimate both:

� The expected return and

� The uncertainty of future returns (Standard Deviation)

Capital Market CharacteristicsRisk (Standard Deviation)

� Standard deviation (σ) is a representation of the risk associated with a given security (cash and cash equivalents, fixed income, equity or a combination (portfolio) portfolio of these

� Recall:


� Recall:

� Expected result = Distribution Average +/- nσ

� ~67% probability that future return = Re +/- 1σ

� ~95% probability that future return = Re +/- 2σ

� ~99.7% probability that future return = Re +/- 3σ

� So knowing the historical rates of return on given asset classes and the historical volatility (σ), one can reasonably assess (analyze) expected future returns

Capital Market CharacteristicsReturn vs. Probability

risk return low 68% 95% 99%

3.3 3.9 Short Term Bonds3.9 3.9 3.9 3.9

Short Term Bonds3.9 7.2 10.5 13.8

Short Term Bonds3.9 0.6 -2.7 -6

19.3 11 Large-Cap Stocks 11 11 11 11

Large-Cap Stocks 11 30.3 49.6 68.9

Large-Cap Stocks 11 -8.3 -27.6 -46.9

24.1 16.2 Small-Cap Stocks16.2 16.2 16.2 16.2

Small-Cap Stocks16.2 40.3 64.4 88.5

Small-Cap Stocks16.2 -7.9 -32 -56.1

low 68%

Short Term Bonds3.9 3.9



Large-Cap Stocks 11 11

Large-Cap Stocks 11 30.3

Large-Cap Stocks 11 -8.3

Small-Cap Stocks16.2 16.2


Small-Cap Stocks16.2 -7.9

-80

-60

-40

-20

0

20

40

60

80

100

low 68% 95% 99%

Probability

Re

turn

Short Term Bonds

Short Term Bonds

Short Term Bonds

Large-Cap Stocks

Large-Cap Stocks

Large-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

0

10

20

30

40

50

Retu

rn

Short Term Bonds

Short Term Bonds

Short Term Bonds

Large-Cap Stocks

Large-Cap Stocks

Large-Cap Stocks

Small-Cap Stocks

20

30

40

50

Retu

rn

Short Term Bonds

Short Term Bonds

Short Term Bonds

Large-Cap Stocks

Large-Cap Stocks



9 10 portfolio 1 10 10 10 10

portfolio 1 10 19 28 37

portfolio 1 10 1 -8 -17

12 11 portfolio 2 11 11 11 11

portfolio 2 11 23 35 47

portfolio 2 11 -1 -13 -25

11 11.5 portfolio 6 11.5 11.5 11.5 11.5

portfolio 6 11.5 22.5 33.5 44.5

portfolio 6 11.5 0.5 -10.5 -21.5

low 68%

portfolio 1 10 10

portfolio 1 10 19

portfolio 1 10 1

portfolio 2 11 11

portfolio 2 11 23

portfolio 2 11 -1

portfolio 6 11.5 11.5



-20

-10

low 68%

Probability

Small-Cap Stocks

Small-Cap Stocks

-30

-20

-10

0

10

20

30

40

50

60

low 68% 95% 99%

Probability

Re

turn

portfolio 1

portfolio 1

portfolio 1

portfolio 2

portfolio 2

portfolio 2

portfolio 6

portfolio 6

portfolio 6

5

10

15

20

25

Retu

rn

portfolio 1

portfolio 1

portfolio 1

portfolio 2

portfolio 2

portfolio 2

portfolio 6

-20

-10

0

10

low 68%

Probability

Retu

rn

Large-Cap Stocks

Large-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks


3.3 3.9 Short Term Bonds3.9 3.9 3.9 3.9

Short Term Bonds3.9 7.2 10.5 13.8

Short Term Bonds3.9 0.6 -2.7 -6

19.3 11 Large-Cap Stocks 11 11 11 11

Large-Cap Stocks 11 30.3 49.6 68.9

Large-Cap Stocks 11 -8.3 -27.6 -46.9

24.1 16.2 Small-Cap Stocks16.2 16.2 16.2 16.2

Small-Cap Stocks16.2 40.3 64.4 88.5

Small-Cap Stocks16.2 -7.9 -32 -56.1

low 68%




Large-Cap Stocks 11 11

Large-Cap Stocks 11 30.3

Large-Cap Stocks 11 -8.3



Small-Cap Stocks16.2 -7.9

-80

-60

-40

-20

0

20

40

60

80

100

low 68% 95% 99%

Probability

Retu

rn

Short Term Bonds

Short Term Bonds

Short Term Bonds

Large-Cap Stocks

Large-Cap Stocks

Large-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

-20

-10

0

10

20

30

40

50

low 68%

Retu

rn

Short Term Bonds

Short Term Bonds

Short Term Bonds

Large-Cap Stocks

Large-Cap Stocks

Large-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Capital Market CharacteristicsReturn vs. Probability

0

20

40

60

80

100

Retu

rn

Short Term Bonds

Short Term Bonds

Short Term Bonds

Large-Cap Stocks

Large-Cap Stocks

Large-Cap Stocks



9 10 portfolio 1 10 10 10 10

portfolio 1 10 19 28 37

portfolio 1 10 1 -8 -17

12 11 portfolio 2 11 11 11 11

portfolio 2 11 23 35 47

portfolio 2 11 -1 -13 -25

11 11.5 portfolio 6 11.5 11.5 11.5 11.5

portfolio 6 11.5 22.5 33.5 44.5

portfolio 6 11.5 0.5 -10.5 -21.5

low 68%

portfolio 1 10 10

portfolio 1 10 19

portfolio 1 10 1

portfolio 2 11 11

portfolio 2 11 23

portfolio 2 11 -1




low 68%

Probability

-30

-20

-10

0

10

20

30

40

50

60

low 68% 95% 99%

Probability

Retu

rn

portfolio 1

portfolio 1

portfolio 1

portfolio 2

portfolio 2

portfolio 2

portfolio 6

portfolio 6

portfolio 6

5

10

15

20

25

Retu

rn

portfolio 1

portfolio 1

portfolio 1

portfolio 2

portfolio 2

portfolio 2

portfolio 6

Clue: Risk must be managed

-80

-60

-40

-20

0

low 68% 95% 99%

Probability

Retu

rn

Large-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Small-Cap Stocks

Asset Class Average Annual Return

Best Return, Year

Worst Return, Year

Historical (1931 – 2001) Class Performance

Capital Market CharacteristicsPerformance Data - Example


Annual Return Year Year

Short Term Investments

3.9% 14.7%, 1981 -0.02%, 1938

Bonds 6.0% 42.6%, 1982 -8.1%, 1969

Stocks 13.5% 54%, 1933 -35%, 1937

Capital Market CharacteristicsPerformance

� Performance expectation should be established based on needs and risk tolerance

� Long term and short term needs and expectations may differ

� Therefore involve different investment strategies


� Therefore involve different investment strategies

� When you diversify, spread your investment over a variety of investment classes, you can smooth both

� Your expected return and

� Variance (standard deviation) on your investment “portfolio”

� Investment funds are measured against benchmarks called market indexes

�A market index is a collection of securities of a similar type (class) accepted by the

Capital Market CharacteristicsPerformance Benchmarks


of a similar type (class) accepted by the financial services industry as being broadly representative of a particular market segment; e.g.

� Dow Jones Industrial Average (the Dow)

� Standard & Poor’s 500 Index (S&P 500)

Capital Market CharacteristicsSome Performance Benchmarks

Index Composition, UseDow Made up of 30 major industrial companies. Barometer for the entire US

stock market. Benchmark for Funds that invest in blue-chip companies (price weighted index)

S&P 500 Made up of 500 leading US companies diversified across 90 different industries. Benchmark for large company US stocks. (market-value-weighted index)

Lehman Brothers Aggregate Bond Benchmark for the overall US bond market, including corporate,


Lehman Brothers Aggregate Bond Benchmark for the overall US bond market, including corporate, government and mortgage bonds

Wilshire 5000 Contains over 7,000 stocks and attempts to capture the behavior of the overall stock market

Russell 1000 A benchmark for large-company US stocks. More broadly diversified than the S&P 500 index. It has separate growth and value versions

Russell 2000 The most common index for tracking small company US stocks. It has separate growth and value versions

NASDAQ Composite Made up ,of mare than 5,000 US stocks, most of them small companies. (market-value-weighted index)

Morgan Stanley Capital International, Europe, Australia, Far East (MSCI EAFE)

Benchmark for developed foreign stock markets

� Use indices to help evaluate fund performance; but

�Use the appropriate index

�Don’t treat them as gospel

Capital Market CharacteristicsPerformance Benchmarks


�Don’t treat them as gospel

� Most are market-value-weighted and are strongly influenced by a small handful of companies

Capital Market CharacteristicsPerformance Data – Another Example


� Portfolio performance drivers (contribution to return) have been determined to be:

�Asset allocation 91.5%

�Investment selection 4.6%

Capital Market CharacteristicsPerformance Drivers


�Investment selection 4.6%

�Market timing 1.8%

�Other 2.1%

Asset Allocation is Key


� 10.0% Annualized Return

� 11.2% Annualized Risk (Standard Deviation) often referred to as volatility

� Back tested Jan 1973 through

60%

S&P 500 IndexStocks

Classical Stock / Bond

Portfolio

Portfolio Strategy for EngineersClassical Stock / Bond Portfolio


� Back tested Jan 1973 through December 2002

� Can we do better?

� Hint

� “Diversification is your only free lunch” Jim Cramer

Return

Risk

67% Expectation -1.2% 21.2%

95% Expectation -12.4% 32.4%

99% Expectation -23.6% 43.6%

Bonds

10.0%

11.2%

40%

Short Term

60%

S&P 500 Index

30%

US Micro Cap

Stocks


Portfolio

Diversify Large Cap /

Small Cap

30%

� Maybe…

� Improved Return

� But more Risk


Portfolio Strategy for EngineersDiversified by Capitalization


Return

Risk

67% Expectation -1.2% 21.2% -1.1% 23.7%

95% Expectation -12.4% 32.4% -13.5% 36.1%

99% Expectation -23.6% 43.6% -25.9% 48.5%

Bonds

11.3%

12.4%

10.0%

11.2%

30%

S&P 500 Index

40%

Short Term

40%

Short Term

better?

� Hint

� Diversify

60%

S&P 500 Index

30%

US Micro Cap

15%

US Micro Cap

15%

US Small Cap Value

15%

S&P 500 Index

Diversify Growth / Value

Stocks


Portfolio


Small Cap

30%

� Yes

� Improved Return

� Less Risk

Portfolio Strategy for EngineersFurther Diversified by Growth / Value


Return

Risk

67% Expectation -1.2% 21.2% -1.1% 23.7% 0.2% 24.2%

95% Expectation -12.4% 32.4% -13.5% 36.1% -11.8% 36.2%

99% Expectation -23.6% 43.6% -25.9% 48.5% -23.8% 48.2%

Bonds

S&P 500 Index

15%

US Large Cap Value

12.2%

12.0%

40%

Short Term

11.3%

12.4%

10.0%

11.2%

30%

S&P 500 Index

40%

Short Term

40%

Short Term

Risk


� Hint

� Same


Portfolio


Small Cap

30%

7.5% US Micro Cap

6.0% Int'l Small Cap

7.5% US Small Cap Value

6.0% Int'l Small Cap Value

6.0% Emerging Markets

7.5% S&P 500 Index

6.0% Int'l Large Cap

Diversify Growth / Value Diversify US / International

Stocks60%

S&P 500 Index

30%

US Micro Cap

15%

US Micro Cap

15%

US Small Cap Value

15%

S&P 500 Index

Portfolio Strategy for EngineersFurther Diversified by US / International


Return

Risk

67% Expectation -1.2% 21.2% -1.1% 23.7% 0.2% 24.2% 0.7% 24.1%

95% Expectation -12.4% 32.4% -13.5% 36.1% -11.8% 36.2% -11.0% 35.8%

99% Expectation -23.6% 43.6% -25.9% 48.5% -23.8% 48.2% -22.7% 47.5%

30%

S&P 500 Index

40%

Short Term

40%

Short Term

11.3%

12.4%

10.0%

11.2%

40%

Short Term

12.4%

11.7%

12.2%

12.0%

40%

Short Term


7.5% US Large Cap Value

6.0% Int'l Large Cap Value

Bonds

S&P 500 Index

15%

US Large Cap Value

Allocation

60%

Stocks6.0% Emerging Markets

7.5% S&P 500 Index


7.5% US Micro Cap




Portfolio Strategy for EngineersThe ideal buy and hold portfolio

� The ideal buy and hold portfolio


� 11.7% Annualized Risk

Re-balance periodically


Return

Risk

67% Expectation 0.7% 24.1%

95% Expectation -11.0% 35.8%

99% Expectation -22.7% 47.5%

40%

Bonds



40%

Short Term

12.4%


11.7%

� Re-balance periodically

� 6 months or Annually

Allocation

60%

Stocks6.0% Emerging Markets

7.5% S&P 500 Index


7.5% US Micro Cap




Portfolio Strategy for EngineersThe ideal buy and hold portfolio

� The ideal buy and hold portfolio


� 11.7% Annualized Risk

Re-balance periodically0

10

20

30

40

50

60

Retu

rn

Basic

Basic

Basic

Ideal

Ideal


Return

Risk

67% Expectation 0.7% 24.1%

95% Expectation -11.0% 35.8%

99% Expectation -22.7% 47.5%

40%

Bonds



40%

Short Term

12.4%


11.7%

� Re-balance periodically

� 6 months or Annually-30

-20

-10

0

low 68% 95% 99%

Probability

Ideal

Ideal

IntroductionStart Early

ReturnEarly Saver

invested $50k

Late Saver

invested $250k

Difference

in accounts

2% $109,491 $326,709 ($217,218)

4% $236,886 $433,117 ($196,231)

� Remember this?


Yes, it can be done

4% $236,886 $433,117 ($196,231)

6% $506,544 $581,564 ($75,020)

8% $1,070,944 $789,544 $281,400

10% $2,239,402 $1,081,818 $1,157,584

12% $4,632,883 $1,593,339 $3,039,544

Allocation All Bonds 30/70 50/50 60/40 70/30 All Equities

% equity 0 30 50 60 70 100

Money and InvestingPerformance Expectations

� For those who have different risk tolerance

� Other stock / bond allocations


% equity 0 30 50 60 70 100

% bonds 100 70 50 40 30 0

Annualized Return 8.8 10.8 11.9 12.4 12.9 14.2

Std. Deviation 4.9 6.9 10 11.7 13.4 18.8

30 yr. Growth of $10k $125,653 $214,170 $291,452 $335,284 $382,153 $535,075

Allocation All bonds 30/70 50/50 60/40 70/30 All equities

Short-term bonds 100 70 50 40 30 0

S&P 500 Index 0 3.75 6.25 7.5 8.75 12.5

U. S. large-cap value 0 3.75 6.25 7.5 8.75 12.5

Money and InvestingEquity allocation diversification

� Suggested Holdings for various allocations


U. S. large-cap value 0 3.75 6.25 7.5 8.75 12.5

U.S. Micro Cap 0 3.75 6.25 7.5 8.75 12.5

U.S. small-cap value 0 3.75 6.25 7.5 8.75 12.5

International large-cap 0 3 5 6 7 10

International large-cap value 0 3 5 6 7 10

International small-cap 0 3 5 6 7 10

International small-cap value 0 3 5 6 7 10

Emerging markets 0 3 5 6 7 10


Money and Investing

� Stock Selection

Roger Manzolini

November 4, 2003


November 4, 2003

� What’s stock?

� Understand what you’re buying

� Companies

� Company fundamentals

Stock SelectionTopics


� Company fundamentals

� What to look for – general

� What to look for – specifically

� Where to look – general

� Where to look – specifically

� A certificate of ownership in a portion of a company

� Stock certificate

�A document representing the number of shares of

Stock SelectionWhat’s stock?


a corporation owned by a shareholder

� Issued by the company as a means to raise money

� You’re buying a stake in the company. So what’s it worth?

� From an accounting viewpoint, a company is worth its “net worth”; that is, shareholders equity (SE)� Recall; A = L + SE; therefore, a company stock share is worth

SE / # of outstanding shares

Stock SelectionUnderstand what you’re buying


� From a technical point of view, a company share is worth its “intrinsic” value

� ((PV of future earnings)-(PV of debt)) / # of outstanding shares

� From a market point of view, a company share is worth what it trades for on the open market

These measures of “worth” are seldom equal. Hint; buy and hold shares where the market price for those shares is less than the shares intrinsic value

A guy sees a sign in front of a house: "Talking Dog for Sale." He rings the bell and the owner tells him the dog is in the back yard. The guy goes into the back yard and sees a black mutt just sitting there. "You talk?" he asks. "Yep," the mutt replies. "So, what's your story?"

The mutt looks up and says, "Well, I discovered this gift pretty young and I wanted to help the government, so I told the CIA about my gift, and in no time they had me jetting from country to country, sitting in rooms with spies and world leaders, because no one figured a dog would be eavesdropping. I was one of their most

Stock SelectionRecognizing value


because no one figured a dog would be eavesdropping. I was one of their most valuable spies eight years running. The jetting around really tired me out, and I knew I wasn't getting any younger and wanted to settle down. So I signed up for a job at the airport to do some undercover security work, mostly wandering near suspicious characters and listening in. I uncovered some incredible dealings there and was awarded a batch of medals. Had a wife, a mess of puppies, and now I'm just retired."

The guy is amazed. He goes back in and asks the owner what he wants for the dog. The owner says, "Ten dollars." The guy says, Good God man, this dog is amazing. Why on earth are you selling him, so cheap?" The owner replies, "He's such a lying SOB; he didn't do any of that stuff!"

� Young, not yet established (highest risk; highest return potential)

� Companies that may emerge as future market leaders

� Traded over the counter OTC) and best left for the most experienced traders with high risk tolerance

� Small-cap (moderate risk; moderate to very high return potential)

Stock SelectionCompanies


� Companies with market capitalization < $500M

� Traded ‘mostly’ on the NASDAQ

� Large-cap (lowest risk; lowest return potential)

� Companies with market capitalization > $5B

� Traded ‘mostly’ on the NYSE

� Mid-cap -- you guessed it, Co’s between $500M and $5B

Hint; your focus could be on Mid-cap and Small-cap companies and managing risk

� Market Capitalization is a measure of corporate size

�The total dollar value of all outstanding shares

�Computed as:

Stock SelectionWhat is market capitalization?


� Total number of shares times current market price

�Shown on trading screens along with trading range, volume,P/E, earnings, …

� Business structure

� Is it simple or is it very complex?

� Ownership

� Insiders, institutions, common shareholders

Management

Stock SelectionCompany fundamentals


� Management

� Visionary leaders or passive caretakers

� All the numbers; financial and otherwise

� Performance

� Growth

� Value

� Simple, well defined, easy to understand businesses

� Companies with insider and institutional ownership

� Companies with visionary leaders, or leaders with a demonstrated, recognized and respected performance record

Improving trends in all numbers

Stock SelectionWhat to look for - general


� Improving trends in all numbers

� Growth trends

� Financial health

� Management performance

� Market multiples

� Intrinsic value

� Examine

� revenues (sales),

� net income (earnings), and

� cash flow

� To see how well a company is translating revenues into

Stock SelectionGrowth trends


� To see how well a company is translating revenues into earnings

� necessary for growth

� Look for companies whose revenues, net income, and cash flow are

� Rising steadily, or

� At faster rates than their competitors

� Long-term and total debt/equity

� compare the company's debt to its assets minus its liabilities

� Reveals how much debt is cutting into the bottom line

� The higher the debt, the more important it is to have

Stock SelectionFinancial health


� The higher the debt, the more important it is to have positive earnings and steady cash flow

� At some point, the company must pay off the debt, or interest payments will sap its finances

� Some industries have more debt, so

� compare the company's debt to the industry average and competitors' debt

� Return on Equity, Return on Assets, and Return on Invested Capital

�Used to measure a company's profitability

�Reveals how successful managers are converting

Stock SelectionManagement performance


�Reveals how successful managers are converting shareholders' equity, assets, and invested capital into net earnings

�Compare to the industry average and competitors to gauge the company's success

� Price/earnings, price/sales, and PEG ratios

�Measure how the market values a stock compared to its earnings, sales, and estimated earnings growth

� A low P/E ratio (in comparison to the industry)

Stock SelectionMarket multiples


� A low P/E ratio (in comparison to the industry) indicates the market is undervaluing a stock

� The P/S ratio is especially important when the company has no reported earnings (and thus no P/E)

� A lower PEG ratio is better because the market is paying a lower price for future earnings

� An indicator of whether a stock is undervalued or overvalued.

� The PEG ratio is the stock's price/earnings ratio (P/E) divided by its forecasted earnings growth rate

� A fairly valued stock would have a PEG ratio of 1; its current P/E and future earnings growth rate being

Stock SelectionPEG ratio


A fairly valued stock would have a PEG ratio of 1; its current P/E and future earnings growth rate being equal

� A ratio of less than 1.0 can be an indication that the stock is undervalued, and poised to grow.

� The usefulness of this calculation depends on the accuracy of the stock's earnings estimates, which you can find at Quotes Plus.

� An intrinsic value/share is a hypothetical value that is based on the

� Company's future earnings (assessment)

� Company's current debt, and the

� Number of outstanding shares

Stock SelectionIntrinsic value


� Number of outstanding shares

� This value can be compared to a stock's current price to help determine if a stock is overvalued or undervalued.

� Warren Buffet looks for stocks that are selling for a discount (Ps < Intrinsic value / 3)

� Good to look at to reduce risk

� More ratios:

� Dividend� yield, growth rate, payout ratio

� Profit margin� Gross, EBITD, operating, pre-tax, net profit, effective tax rate

Stock SelectionWhat else should you look for - general


� Other efficiencies� Per employee: revenue, net income

� Turnover: receivables, inventory, asset

� Float: common shares / # shares outstanding� Generally, insiders and institutions aren’t actively trading;

therefore, float is indicative of “supply”. Low float, high volatility

� Earnings relative to market cap: >10X

� Analysis of a company’s

�Strengths and

�Weaknesses

Used to establish strategies and plans to exploit

Stock SelectionSWOT


� Used to establish strategies and plans to exploit and address

�Opportunities and

�Threats

� An analysis that assesses impacts to a company’s future due to various “environmental” factors

� S-E-P-T-E-D Analysis

� The model divides the external environment of business into six segments for analysis

Stock SelectionSEPTEmber moDel


into six segments for analysis

� Sociocultural

� Economic

� Political/Legal

� Technological

� Ecological

� Demographic

� Porter’s 5 Force Analysis

�The intensity of industry competition and an industry’s profit potential are a function of five competitive forces

Threats Posed by New Entrants

Stock SelectionPorter’s five forces


� Threats Posed by New Entrants

� Power of the Suppliers

� Power of the Buyers

� Threat of Substitutes

� Rivalry Among Competitors

� Look for change(s)

� Market changes� What’s new (hot), what’s not, …

� E.g. nylons in an egg, disposable razors, VCRs, PC’s, cell phones, viagra, …, nano-technology, biometrics, …

� Environmental changes

Stock SelectionWhat else should you look for - general


� Environmental changes� Societal, legal, political, weather, …, whatever

� E.g. terrorism, fire/storm catastrophes, war, …

� Technology changes� Medical, financial, technical, …

� Notice macro changes too� Debt growth, aging society, world developments, …,business

changes. E.g. GE evolution away from production to service

� From “How to Make Money in Stocks; A Winning System in Good Times or Bad” by William J. O’Neal, founder of the Investors Daily

� CANSLIM

� Current quarterly earnings per share (EPS)

Annual earnings increases

Stock SelectionWhat to look for – point specific


� Annual earnings increases

� New products, new management, new highs

� Supply and demand

� Leader or laggard

� Institutional ownership

� Market direction

� How much is enough?

�More than 20% over same quarter last year

� Watch out for misleading reports

� Omit one time extraordinary gains

Stock SelectionCurrent quarterly EPS


�Accelerating quarterly earnings growth

� “rate of change of earnings”

� The change and improvement from the prior rate of earnings increases

� Two quarters of earnings deceleration may mean trouble!

� Look for meaningful growth

�Annual earnings growth rate of 15 to 50%

�Stable five-year record

� Insist on both annual and current quarter

Stock SelectionAnnual earnings increases


Insist on both annual and current quarter earnings being excellent

Earnings are the most critical fundamental factor available for selecting potential winning stocks

� Buying at the right time�The value created by new products are easy to

understand� E.g. Tupperware, Polaroid, oral contraceptives, fast food franchising,

wholesale warehouse membership stores, …

�New management; similarly easy to understand

Stock SelectionNew products, management, highs


�New management; similarly easy to understand� Potential current opportunity?….TYCO

�New highs…….hum? Is this a paradox?� Many independent studies have shown that stocks listed on the new

highs list tend to go higher; contrary to most popular thinking “buy low, sell high”, consider “buy high, sell higher”

� Stocks listed on the new lows list tend to go lower; avoid them

�Always look for new ‘whatever’ and who owns the patent� Opportunities: Nano-technology, biometrics, oral insulin, AIDS, …

� Small capitalization plus volume demand

�The law of supply and demand is more important than all the analyst opinion on Wall Street

� Big is not better

Stock SelectionSupply and demand


�Most meaningful growth (opportunity) has already occurred

� Look for companies buying their own stock

�Reduces common stock shares (supply); therefore, tends to drive the stock price higher

� Which is the company (stock) being considered?

� Buy among the best 2 or 3 stocks in a group (same industry)

� We all know the winners, but who came in next?

� For example, who here knows the name of the cyclist (yes,

Stock SelectionLeader or laggard


� For example, who here knows the name of the cyclist (yes, it was the same person) who came in second in all five of Lance Armstrong’s consecutive Tour de-France wins?

� Always sell laggards first, hold leaders until your in good profit, or until the reasons you bought no longer apply

It seldom pays to invest in laggard performing stocks even if they are invitingly cheap. Look for and buy market leaders

� A little can go a long way� Its like sponsorship in the form of mutual funds, corporate

pension funds, insurance companies, .. You get the idea

� If a stock has no ‘sponsors’, it is likely that its performance is ‘run-of-the-mill’, and chances are that many institutional

Stock SelectionInstitutional ownership


is ‘run-of-the-mill’, and chances are that many institutional investors looked at the stock and passed it over in favor of another

� Look at institutional ownership quarterly trend. Decreases can be a red flag

� Look at the ‘quality’ of ownership

Buy stocks that have at least a few institutional sponsors with a recent better than average performance record

� Which way is it going? How to determine it?

� In order to get a reasonable handle on the answer to these questions, one must be strongly ‘connected’ to the market.

�At a minimum one must read the financial papers

Stock SelectionMarket direction


�At a minimum one must read the financial papers (Investors Daily, Wall Street Journal, …)

� I’d suggest that investors get the Investors Daily and also rely on an ‘expert’ in the field

Be guided with the help of an ‘expert’ to get a handle on Market direction

� Everywhere around you

�At home, at work, and when you are out and about

� Notice what is hot with teenagers, techies, and the elderly (all large consumer groups)

Stock SelectionWhere to look – general


elderly (all large consumer groups)

�Financial news

� Papers, magazines, newsletters

� Internet

� Yahoo Finance, MS money, cnnmoney

� Quicken

� Barchart

� *http://www.moneycentral.com

� Lots of good info links here

� Click Investing

� Click Screener, more

� To create your own customized searches

Stock SelectionWhere to look – specific


� To create your own customized searches

� Click power searches

� To get a selection of searches based on

� Technical analysis or

� Fundamental analysis factors of the underlying companies

� *http://www.corporateinformation.com/

� Lots of good info links here too

� Click United States to get several ‘categorized’ links

� Comparison to other firms

� Delayed quotes and graphs



� Delayed quotes and graphs

� Earnings estimates and analysts reports

� General information

� Historical data

� Ownership information

� *Screening

� Other useful information

� *www.quicken.com

� Click ‘stock evaluator’ to� Appraise the health and performance of a company

� Get intrinsic value

� Click ‘one-click stock analysis’ to get perspective from



� Click ‘one-click stock analysis’ to get perspective from four different investing strategists

� These are useful ‘stops’ to reduce risk

� *http://quotes.barchart.com/texpert.asp?sym=gd

� Good reference to get ‘opinion’ (Buy / hold / sell), and classical technical ‘indicators’

� Another useful ‘stop’ to reduce risk

� Motley Fool's Foolish 8 Strategy

� The Motley Fool helps you identify fast-growing small-cap companies using the Foolish 8 strategy

� *Strong interest stocks

� Robert Hagstrom's The Warren Buffett Way

Stock SelectionQuicken Strategists


� Robert Hagstrom's The Warren Buffett Way

� Fund manager Robert Hagstrom, author of the New York Times best-seller The Warren Buffett Way, demonstrates how one of history's all-time great investors identifies his favorite buys. Hagstrom shows you how Buffett judges a company's management, financials and price


� NAIC's Established Growth Strategy� The National Association of Investors Corporation (NAIC) shares

their time-tested growth stock strategy with Quicken.com users. Since 1951, the NAIC has helped investment clubs and individuals identify blue-chip stocks likely to double in 5 years


Stock SelectionQuicken Strategists



� Geraldine Weiss' Blue-Chip Value Strategy� Experts have ranked Geraldine and Gregory Weiss' newsletter,

Investment Quality Trends, among the top ten percent in the field over the last 15 years. The Weiss' show you how they find high-quality, high-yielding income stocks selling at attractive prices


� Stock Screener - From Hoover's. This is really a good site if you want to screen stocks based on many different criteria, including price/book, P/E, growth rates, size, ratios, etc. One of the best sites for screening. Also, when you get the list of companies, one click gives you the profiles provided by Hoover's. You can also restrict

Stock SelectionScreening


the profiles provided by Hoover's. You can also restrict your search to a particular industry (which might be useful).

� Research Mag - Has a stock screening criteria which is fairly similar to that offered by stock screener. Also allows you to graph several stocks on the same graph so you can see how they've performed in relation to the other.

� Market Player - Allows screening on many variables, including expected future earnings. Has a very powerful screening engine, but it looks like it'll take some practice to become comfortable with it. But they also have a simple screening which is more user friendly, but not as

Stock SelectionScreening (cont.)


simple screening which is more user friendly, but not as powerful. This site requires registration, but it's free.

� *Stock Selector - Allows general or industry-specific screening on price/book, analyst recommendations, P/E, PEG, dividend yield, five year estimate Earnings growth rate and five year historic growth rate.

� Wall Street Research Network - Allows screening on P/E, Price/Sales, Price/Book, Price, yield, beta, EPS change, sales, market cap and index membership.

� StockTools - From this site, you can choose stocks based on criteria, including the industry. Other criteria

Stock SelectionScreening (cont.)


based on criteria, including the industry. Other criteria are P/E, volatility, Yield, shares outstanding, market cap, price, change in price, and others.

� Finance.yahoo.com� Scottrade.com� Investools.com

� Uses Fundamental Analysis to determine what stocks to own

Scores 13 key fundamentals

Stock SelectionWhat I use


� Scores 13 key fundamentals � Volume Ratio 5/30 Day, P/E Ratio, P/E Relative Ratio, Projected EPS 1M Chg CFY,

EPS Growth 5 Yr, Company Growth Ratio, Acc. Dist Current, Cash Flow Growth 5 Yr, Debt/Equity Ratio, Insider Trading, EPS Rank, 5 Price Rank, Group Rank

� Uses Technical Analysis to determine when to buy, hold, and sell� Scores 3 key charts – used conjuntively

� 30 day rolling average� MACD(8,17,9) – a simple momentum indicator (trend following & momentum)� STO (14,5,0) – a timing indicator


Buy


Sell



$ Stock shares

Start 10,000.00$ -

buy @ 67.50$ - 148.15

sell @ 75.10$ 11,125.93$ -

buy @ 61.25$ - 181.65

sell @ 61.20$ 11,116.84$ -

buy @ 60.00$ - 185.28

sell @ 65.20$ 12,080.30$ -


Money and Investing

� Financial Ratios

Roger Manzolini

October 20, 2003


October 20, 2003

Money and InvestingFinancial Ratios

�First recall income statement:Sales

- CGS- DepreciationEBIT (earnings before interest and taxes)

- Interest


- InterestTaxable Income

- TaxesNet Income (also called earnings)

�Net Income = Earnings�Available for payouts (dividends), and�Plowback (retained earnings and reinvestment in company)

� Leverage Ratios


�Total debt ratio = Total Assets

Total Debt

A measure of how much of the companies assets are financed by debtTypically want this to be less than 1; otherwise be concerned


�Debt equity ratio = Total Equity

Total Debt

�Times interest earned = Interest Payments

EBIT

Typically want this to be greater than 1; otherwise be concerned

Typically want this to be less than 1; otherwise be concerned

Typically want this to be less than 1; otherwise be concerned

� Liquidity Ratios


�Current ratio = Current liabilities

Current assets

A measure of the company’s ability to pay its debt; i.e. to stay a viable company.


A measure of the company’s ability to pay its debt; i.e. to stay a viable company.

Typically want this to be greater than 2

Lower values are a sign of trouble

� Efficiency Ratios


�Inventory turnover ratio = Inventory

CGS

Sales

The higher the betterTypically greater than 20 is considered good


�Receivables Turnover (RT) = AR

Sales

�Days’ sales in receivables = RT

365

The lower the betterDays inventory is on hand. Typically less than 4 is considered good

The lower the betterTypically less than 4 is considered good

� Profitability Ratios


�Profit margin = sales

Net income

Net income

The higher the betterTypically greater than 15% is considered good


�Return on assets (ROA) = Total assets

Net income

�Return on equity (ROE) = Total equity

Net income



� The Dupont System


�ROA = sales

Net income

assets

salesX

asset profit


�ROE = equity

assetsX

leverageratio

assetturnover

profitmargin

sales

Net income

assets

salesX

assetturnover

profitmargin

� Profitability Ratios


�payout ratio = earnings

dividends

How much of the companies earnings are returned to the shareholderTypically GE payout ratio has been ~ 12%


�plowback ratio = earnings

Earnings - dividends

Typically GE payout ratio has been ~ 12%

= 1 – payout ratio

� Market Value Ratios


�Earnings per share = # of shares outstanding

Net income

The higher the betterTypically GE EPS has been ~ 12%


�Price earnings (PE) = Earnings per share

Stock price

The lower the better; less risk to investor; not ‘over-priced’Typically GE PE has ranged from ~ 9 to ~ 18Typically the market PE has ranged from ~ 15 to ~ 30

� Market Value Ratios


�Dividend yield = Stock price

Dividend per share

The higher the better


�Market to book ratio = Book value per share

Stock price

The higher the betterGreater than 4% is considered good

The higher the betterVaries between industries


Money and Investing

� Top 10 Things to Know

Roger Manzolini

November 25, 2003


November 25, 2003

1. Over the long term, stocks have historically outperformed all other investments.� From 1926 to 2001, the stock market returned

an average annual 10.7 percent gain.� The next best performing asset class, bonds,

returned 5.3 percent.

Money and InvestingTop 10 Things To Know (CNN and MONEY magazine)


The next best performing asset class, bonds, returned 5.3 percent.

2. Over the short term, stocks can be hazardous to your financial health.� On Oct. 28,1997, the Dow dropped 554-points

(7.2%).� 10 years earlier, on Oct. 19, 1987 -- the worst

one-day drop in stock market history -- the Dow

Money and InvestingTop 10 Things To Know


10 years earlier, on Oct. 19, 1987 -- the worst one-day drop in stock market history -- the Dow dropped 508-points (22.6%).

� In March 2000, if you had invested in a Nasdaq index fund around the time of the market's peak, you would have lost three-fourths of your money over the next three years.

3. Risky investments generally pay more than safe ones (except when they fail).� Investors demand a higher rate of return for

taking greater risks.� That's one reason that stocks, which are

perceived as riskier than bonds, tend to return



That's one reason that stocks, which are perceived as riskier than bonds, tend to return more than bonds.

� It also explains why long-term bonds pay more than short-term bonds.� The longer investors have to wait for their final

payoff on the bond, the greater the chance that something will intervene to erode the investment's value.

4. The biggest single determiner of stock prices is earnings.� Over the short term, stock prices fluctuate based

on everything from� interest rates, to



� investor sentiment, to� the weather; you name it,

� But over the long term, what matters are earnings.� If a stock's earnings rise substantially over the

course of 10 years, so will its share price.

5. A bad year for bonds isn’t really all that bad compared to a bad year for stocks.� In 1994, the worst year for bonds in recent

history, intermediate-term Treasury securities fell 1.8%, and the following year they bounced back 14.4%.



14.4%.� By comparison, in the 1973-74 crash, the Dow

Jones industrial average fell 44%. It didn't return to its old highs for more than three years or push significantly above the old highs for more than 10 years.

6. Rising interest rates are bad for bonds.� When interest rates go up, bond prices fall.

� Why? Because bond buyers won't pay as much for an existing bond with a fixed interest rate of 5 percent as they will for a new one that is paying, say, 6 percent or more.



say, 6 percent or more.

� Conversely, when interest rates fall, bond prices go up in lockstep fashion.� And the effect is strongest on bonds with the

longest term, or time to maturity. That is, long-term bonds get hit harder than short-term bonds when rates climb, and gain the most when rates fall.

7. Inflation may be the biggest threat to your long-term investments.� While a stock market crash can knock the

stuffing out of your stock investments, so far, the market has always bounced back and eventually gone on to new highs.



gone on to new highs.� However; inflation, which has historically stripped

3.2 percent a year off the value of your money, rarely gives back what it takes away.� That's why it's important to put your retirement

investments where they'll earn the highest long-term returns.

8. U.S. Treasury bonds are as close to a sure thing as an investor can get.� The conventional wisdom is that the U.S. Government is

unlikely ever to default on its bonds.� partly because the American economy has historically been

fairly strong and,



fairly strong and,� partly because the government can always print more

money to pay them off if need be.

� As a result, the interest rate of Treasuries is considered a risk-free rate, and the yield of every other kind of fixed-income investment is higher in proportion to how much more risky that investment is perceived to be.

� Of course, your return on Treasuries will suffer if interest rates rise, just like all other kinds of bonds.

9. A diversified portfolio is less risky than a portfolio that is concentrated in one or a few investments.� Diversifying (spreading your money among a

number of different types of investments) lessens your risk;



your risk;� because even if some of your holdings go down,

others may go up (or at least not go down as much).

� On the flip side, a diversified portfolio is unlikely to outperform the market by a big margin for exactly the same reason.

10. Index mutual funds often outperform actively managed funds.� In an index fund, the manager sets up his

portfolio to mirror a market index-- such as Standard & Poor's 500-stock index -- rather than actively picking which stocks to purchase.



actively picking which stocks to purchase.� This is often good enough to beat the majority of

competitors among actively managed funds.� One reason

� Few actively managed funds can consistently outperform the market by enough to cover the cost of their generally higher trading fees.


� What does it take?� Willingness to accept some risk

� The “risk-free” rate of return (ror) is 4-5% with low volatility

� To beat this “risk-free” ror risk must be taken� The “moderate allocation portfolio” ror is 8-10% with

moderate volatility

Money and Investing Parting thoughts


moderate volatility

� The “market” ror is 10-12% with high volatility

� Time to educate yourself� Markets

� Fundamental analysis (FA)

� Technical analysis (TA)

� Trading� Stocks, bonds, options

� What does it take? (continued)

� Time to manage your portfolio

� Positive attitude

� Belief in yourself that you can do it

� Separation of emotion from trading decisions



� Separation of emotion from trading decisions

� FA and TA decisions vs. emotional decisions

� Knowledge vs. guessing

� Learning from your mistakes

� Tenacity to continue

� Warren Buffet

�“When everyone is greedy, be scared; When everyone is scared, be greedy”

� Peter Lynch (In response to: To what do you attribute your success?)



� Peter Lynch (In response to: To what do you attribute your success?)

�“I always sold too soon”

� William Simons (When he was the secretary of the US Treasury and

being questioned about the National Budget)

�“What do you expect; for us to account for

every million”

Documents

EWHieeeOrg R1 Berkshire Notices InvestmentStrategyForEngineersNovember192010