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Assignment 3: Value and Growth Screens Value...

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Assignment 3: Value and Growth Screens Value Screens Value investing is a disciplined investment approach using valuation measures that help to avoid the emotional traps of the market. Stocks and markets are driven by emotions that often push prices from their intrinsic value. The value strategies seek to profit from other investors' misjudgments by seeking stocks that are out-of-favor or neglected by the market and by avoiding the high-flying fashionable stocks that have been swept up by market euphoria. Eventually the market rediscovers out-of-favor stocks and lets the high-fliers fall back to earth. This is why value investing is sometimes called contrarian investing. Value investing selects stocks that are priced low relative to measures of worth, such as sales, earnings, operating cash flow, assets and equity. Common measures of value include low price-earnings, price-sales, low price-to-operating cash flow, low price-to-book ratios and high dividend yields. This is not to say that all firms with lower price-X ratios or high dividend yields are good values. To be a good value, they must be able to show some potential. Realize that many stocks with low price-X ratios have little potential and deserve their low multiples! Free cash flow to the firm (FCFF) was used as input to stock valuation in Assignment 2. With strong free cash flow, debt can be retired, new products developed, stock can be repurchased, and dividend payments can be increased. Excess free cash flow also makes a company a more attractive takeover target. A screen for positive and consistent free cash flow is a good starting point for the investor scanning for value firms on a cash flow basis. If including a free cash flow screening criteria, it is a good idea to look only at firms with a market cap greater than or equal to 50 million. This restriction excludes small stocks with poor trading liquidity. In addition, you should not apply any FCFF screening criteria to financial firms. Financial firms do not typically have large expenditures in brick and mortar property, plant, and equipment expenditures. However, they make significant investments in marketable securities, which are not considered in the standard free cash flow calculation. When looking at the cash flow of a financial firm it would be best to examine total cash flow figures from the statement of cash flows. As a general rule of thumb, screens that focus primarily on value stocks tend to produce a set of stock that can show less price volatility than screens that focus on pure growth stocks. Further, value stocks tend to have less portfolio turnover. Typically, they do not invest in smaller firms, preferring to focus on companies that are more mature and mid-sized or larger in terms of market capitalization. Historical earnings growth rates are rarely much above the market average, and the prices of the selected stocks do not tend to have momentum relative to the market. Value approaches tend to outperform other approaches during bear markets, but they can fall behind during bull markets, particularly during the strongest portion. However, as with all screens, a study of the annual report and an understanding of the company, its products, and its industry are required. Q1. Use the list of characteristics of value stocks that are shown in Table 1 along with those from the various AAII Value Stock Screen articles shown in Table 2 and from the Free Cash Flow Value Screen in Table 3 to create YOUR OWN value screen using either the Yahoo Finance or the AAII Stock Investor Pro screener. Keep it simple and use no more than five (5) to ten (10) screening criteria for this assignment. As a general rule, the more criteria you specify and the stronger (the more limiting) your criteria, the smaller will be your sample of stocks that pass your screen. i) LIST the five (5) to ten (10) value criteria you have selected for your screen and EXPLAIN your screening criteria choices. ii) LIST the total number, not names, of firms that your screen generates. iii) Based on what you have learned in the course to date, SELECT what you believe to be the best three (3) to five (5) firms from your list for immediate investment and JUSTIFY your selection. As with all screens, a study of the annual report and an understanding of the company, its products, and its industry are required. Table 1: Common Criteria for Value Stocks Ample cash as a current asset (cash > 10% of market cap) Ample cash flow to fund necessary investment (net income > capital spending) Conservative dividend payout policy (dividend < 50% of EPS) Conservative financial structure (debt/equity < 1.0 ) Conservative issuance of common stock to managers and other employees (constant or falling number of shares outstanding). Low price-book ratio relative to the market (P/B < 75% of S&P 500 or DOW). Low price-cash flow ratio relative to the market (P/CF < 75% of S&P 500 or DOW). Low price-earnings ratio relative to the market (P/E < 75% of S&P 500 or DOW). Significant dividend yield (yield > 150% of S&P 500 average) Table 2: Criteria for Value Stocks from Various AAII Screens Strategy P/E Ratio (X) Price- to-Book Value Ratio (X) Price- to-Sales Ratio (X) P/E to EPS Est. Growth (X) Hist. EPS Growth (%) Est. Long -Term EPS Growth (%) Market Cap ($ Mil) 52-Week Relative Strength (%) Value Cash Rich Firms 18.5 1.5 1.8 1.5 22.5 14.6 528.8 10.0 David Dreman 16.9 1.9 1.0 2.2 4.2 5.9 94,110.7 -18.0 David Dreman With Est Revisions 12.5 1.7 1.0 1.2 18.3 10.1 6537.8 14.5 Dividend Screen?DRPs 13.1 2.0 1.5 1.6 11.8 8.8 9,930.0 -13.5 Dividend Screen?Non-DRPs 11.1 1.2 1.0 1.5 5.5 11.8 184.8 -15.5 High Relative Dividend Yield 17.1 1.9 1.8 1.5 11.9 10.0 3,146.6 -14.0 Dogs of the Dow 16.1 2.2 1.1 2.6 14.8 5.7 80,747.6 -16.5 Dogs of the Dow--Low Priced 5 1.3 1.9 1.0 2.2 4.2 5.9 94,110.7 -18.0 Low Price-to-Free-Cash-Flow 11.9 1.0 0.4 1.3 -25.5 10.4 302.8 5.5 Fundamental Rule of Thumb 5.1 2.6 1.6 1.0 20.3 16.0 334.7 0.0 Graham?Defensive Investor (Non-Utility) 15.3 1.8 1.1 1.5 15.4 10.6 2,440.5 3.0 Graham?Enterprising Investor 6.2 1.0 0.3 0.0 17.7 -3.9 348.4 22.0 Josef Lakonishok 18.7 2.0 1.2 1.6 14.1 10.7 2187.0 13.0 John Neff 9.1 1.2 1.2 0.8 27.2 14.2 395.9 -23.0 O'Shaughnessy?Value 15.4 2.0 1.0 3.0 4.5 4.6 19,517.3 0.0 Joseph Piotroski 27.6 0.7 1.6 0.0 -8.0 0.0 27.2 143.0 P/E Relative 15.0 2.9 1.4 1.4 17.8 10.7 3032.4 7.0 Schloss 7.1 0.5 1.0 19.2 -26.0 10.0 9.2 -37.0 Weiss Blue Chip Div. Yield 16.0 3.1 1.2 1.6 17.0 11.1 7,196.0 0. Table 3: Free Cash Flow Screen Market cap greater than or equal to 50 million Exclude financial firms Positive free cash flow for each of the last five fiscal years Positive free cash flow for the most recent 12 months Price-to-free-cash-flow ratio below their industry price-to-free-cash-flow ratio median Price-to-free-cash-flow ratio below the company's own five year average Growth Screens Growth investing is concerned with selecting stocks that will exhibit above-average and increasing growth. Growth investors look for industries and companies that are in the aggressive growth and growth stages of their life cycle?a period associated with rapid and increasing growth rates in sales and earnings with still-reasonable profit margins. Minimally, growth companies are growing above the rate of the overall economy. Practically speaking, however, the benchmark for being classified as a growth stock is a 15% to 20% annual growth rate in earnings per share. Unless you are looking at a cyclical company coming out of a slump, growth rates this high generally require capital spending to maintain expansion. Growth stocks will therefore retain most of their earnings and have low dividend yields. Investors looking for high-dividend-yielding stocks will generally look for firms late in the growth stage or in the mature stage. One weakness with growth stocks, especially those in the aggressive growth stages, is that internal cash flow may not be able to support growth and, thus, more capital by issuing additional shares will be required. These firms will normally generate a negative FCFF. This may have the effect of diluting the existing ownership of shareholders. Stocks with high growth and good prospects attract a great deal of attention. Price tends to be bid up with high anticipation. High expectations relative to current levels of earnings lead to high price-earnings, P/E, ratios along with high P/S and P/BV ratios. It is not uncommon to see highly touted growth stocks with price-earnings multiples two to four times the market. As long as a firm maintains its earnings per share momentum and exceeds the growth expectations of the market, its stock price can be expected to increase tremendously. Growth stocks, however, tend to be volatile. A small deviation from market expectations during a quarterly earnings announcement can send the price flying in either direction. Institutional investors own a large percentage of growth stocks and when they all try to head for the exit door the price can tumble. Growth strategies want to buy growth, period. Their focus is on companies that are rapidly expanding their sales and earnings. Often, these stocks are already on the move, with prices typically moving up faster than the market. The approach tends to be more volatile-prices can move up or down substantially, with small changes in expectations-and it tends to perform better on a relative basis late in the bull market or when the economy is slightly down. For these reasons, investing in growth stocks requires close monitoring. Q2. Use the list of characteristics of growth stocks that can be found in Table 4 along with those from the various AAII Growth Stock Screens shown in Table 5 to create YOUR OWN growth screen using the Yahoo Finance or the AAII Stock Investor Pro Screener. Keep it simple and use no more than five (5) to ten (10) screening criteria for this assignment. i) LIST the five (5) to ten (10) growth criteria you have selected for your screen and EXPLAIN your choices. ii) LIST the number of firms that your screen generates. iii) Based on what you have learned so far in the course, SELECT what you believe to be the best three (3) to five (5) firms from your list for immediate investment and JUSTIFY your selection. As with all screens, a study of the annual report and an understanding of the company, its products, and its industry are required. Table 4: Common Criteria for Growth Stocks Growth stocks display high profit margins. Growth stocks display an attractive return on total assets (ROA). Growth stocks display low debt ratios. Growth stocks lack cutthroat competition. Growth stocks have superior research. Growth stocks have low overall labor costs. Growth stocks pay high wages. Growth stocks are immune from regulation. Table 5: Criteria for Growth Stocks from Various AAII Screens Strategy P/E Ratio (X) Price- to-Book Value Ratio (X) Price- to-Sales Ratio (X) P/E to EPS Est. Growth (X) Hist. EPS Growth (%) Est. Long -Term EPS Growth (%) Market Cap ($ Mil) 52-Week Relative Strength (%) Growth Richard Driehaus 18.5 3.6 3.6 1.9 8.0 27.5 704.0 69.0 Foolish Small Cap 8 15.8 3.6 4.5 1.4 47.3 29.5 440.3 276.5 Kirkpatrick Growth 47.1 2.4 3.4 2.2 -18.2 10.0 3,467.9 99.0 IBD Stable 70 20.7 4.0 2.2 1.0 39.1 18.8 1,168.7 37.0 Inve$tWare Quality Growth 20.4 5.3 3.4 1.1 32.4 16.9 3,261.2 -3.5 O'Neil's CAN SLIM 11.2 3.5 3.4 0.0 47.3 0.0 367.8 687.0 O'Neil's CAN SLIM Revised 3rd Edition 31.6 7.2 4.4 1.7 47.3 24.8 1242.2 447.0 Return on Equity 20.1 4.8 2.2 1.4 32.3 15.8 836.2 10.0 Additional AAII Growth Screen Criteria: Growth in earnings per share from continuing operations over the last five years must be 25% or more The year-to-year growth rate in earnings per share from continuing operations has increased over each of the last four fiscal years (Y4 to Y3, Y3 to Y2, etc.) Growth in earnings per share from continuing operations over the last 12 months has been positive At least three analysts have provided earnings estimates for the current fiscal quarter (Q0) The percentage change in stock price over the last four weeks is positive The 26-week relative price strength is greater than or equal to the industry's 26-week relative price strength The market capitalization for the latest fiscal quarter (Q1) is greater than $50 million and less than $3 billion Those companies that trade as American Depository Receipts (ADRs) are excluded The current stock price must be within 10% of its 52-week high The 52-week relative strength must be in the top 30% of the entire database (percent rank greater than 70) Return on equity for the last 12 months and for each of the last five fiscal years is greater than 1.5 times the industry median return on equity for the same periods The net margin for the last 12 months is greater than the industry's median net margin for the same period The total liabilities to total assets ratio for the last fiscal quarter (Q1) is less than the industry's median total liabilities to total assets ratio for the same period The asset turnover for the last 12 months is greater than the industry's median asset turnover for the same period

 

Paper#2593 | Written in 18-Jul-2015

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