by Doug Gerlach ICLUBcentral Inc. September 2006 Investing 101 by Doug Gerlach ICLUBcentral Inc. September 2006

What Is a Security? Investment instrument issued by corporation, government or other organization which offers evidence of debt or equity Stock (equity) Bond Option Mutual Fund

What Is a Stock? Ownership share of a company Shares of publicly-owned companies trade on an exchange or market Share price determined solely by supply & demand Bid: amount investors are willing to pay Ask: amount owners are willing to sell for Last: amount of most recent trade Close: last trade of the day

Why Invest in Stocks?

What Is Trading? Buying & selling securities on short-term basis, hoping to make quick profits Usually relies on technical analysis Assumption that future price of a stock can be predicted by historical prices, volume and/or other variables Focuses heavily on charts Does not consider intrinsic value of security (unlike fundamental analysis) Assumes that market psychology influences trading in a way that predicts when a stock rises or falls Market timing: technical analysis applied to market as a whole

What Is Investing? Buying a security with an expectation of favorable future returns over long-term Usually relies on fundamental analysis: Examining company's financials, especially sales, earnings, growth potential, assets, debt, management, products & competition Only considers variables directly related to company’s operations, not overall state of market or technicals

Fundamental? Technical? Two different approaches to stock market Some blend both approaches Some say neither is valid! Random Walk Theory: claims that prices follow random path up and down, without any influence by past price moves Impossible to predict which direction the market will move at any point Impossible to outperform market without taking on additional risk However, some proponents do acknowledge that markets move gradually up in long run

Trading vs. Investing Trading: requires constant attention Generates many transactions Increased costs due to commissions More complex tax filings, higher taxes on short-term gains Uses often-complex tools and methods Heavy use of charts & pattern recognition Technical indicators that drive buy/sell decisions

Typical Trading Chart

Investing vs. Trading Investing: requires minimal time and effort Few hours for research of new stock Few hours a quarter for portfolio maintenance Fewer transactions 12-20 stocks can make a diversified portfolio Lower commission & costs Lower tax rate for long-term capital gains Requires understanding of general business principles Buy-and-hold approach favors long-term horizon

Fundamentally: Value Investing Looks for undervalued companies Favors good stocks at great prices (over great stocks at good prices) Utilizes valuation measures such as price to book ratio, price/earnings ratio, yield Often looks for hidden assets Graham and Dodd, Warren Buffet, John Templeton

Fundamentally: Growth Investing Looks for stocks with strong past earnings & revenue growth and growth potential in the future Growth in earnings will ultimately translate into increase in stock price Favors great stocks at good prices Think like an owner of a business

Fundamentally: Other Approaches GARP (Growth At a Reasonable Price): hybrid of growth and value used by Peter Lynch Income Investing: picking companies that provide steady stream of dividends CANSLIM: developed by William O'Neil of Investor's Business Daily blends fundamentals & technicals Dogs of the Dow: annually buying 10 companies in Dow Jones Industrial Average with highest dividend yield

What We Believe Long-term buy-and-hold approach is best for individual investors Over long-term (5-10 years +), stocks provide best reward compared to risk Regular investing strategies (such as dollar cost averaging) can lower risk Possible to outpace S&P 500 (10-12% annual return) over time with well-selected, well-managed portfolio

Isn’t It Too Hard to Pick Stocks? Stocks can be very risky in short-term (less than 5 years) So maintain a long-term focus It can be hard to pick individual stocks that will do well So let software help ICLUBcentral’s tools are best available for long-term, growth stock investors

Blatant Self-Promotion “One excellent package is the Investor’s Toolkit. This software is a great tool to help investors stop themselves from potentially paying too much for a stock.”

How to Invest in Stocks Find good companies Buy them cheap That’s it!

What Is a “Good Company”? Answer two questions: Are profits growing consistently & adequately each year? Is profit margin stable?

Historic Growth Past growth of earnings (and revenues) should be consistent When graphed, should appear as a fairly straight line moving upward Past growth of earnings (and revenues) should be adequate for size of company Large companies grow slower than small companies

Is This Growth Consistent? AT&T Impossible to predict growth!

How About This? Bed Bath & Beyond

Are Profit Margins Stable? Profit margin: % of profit the company makes on each $ of sales Margins vary from industry to industry Should be consistent year to year, or even growing Declining profit margins can be sign of trouble!

Are These Margins Stable? AT&T

And How About These? BBBY

What About Future Growth? Once you’ve determined historic growth is adequate, estimate future EPS growth Past growth gives good clue about future potential Your research on company can provide other drivers (or hindrances) to growth

What Would You Predict? AT&T Impossible to predict growth!

How About This? Bed Bath & Beyond

Measuring Past Growth First step – measure past growth. Computer is good at this: Sales, 24.9%, EPS 29.7%

Estimating Future Growth

I’ve Found a Good Company! What next? 2nd step – buy it cheap!

What Makes a Stock Cheap? If a stock is: Growing strongly and consistently AND You can pay less than investors have on average in the past for a stock THEN You might be getting a bargain! Measure this with P/E Ratio

What Is the P/E Ratio? P/E Ratio = Current Price ÷ Annual EPS How much are investors willing to pay for a stock per dollar of earnings? By itself, P/E doesn’t tell you much Allows you to compare stock: To other stocks To overall market To own history To expected EPS growth rate PEG Ratio = P/E Ratio ÷ EPS Growth Rate

Considering the P/E Ratio Apple Computer’s P/E is currently 35.9 Is that high or low, expensive or cheap? S&P 500 average P/E is currently about 17.6 Dow Jones Computer Hardware industry average P/E is currently 25.2 In 2005, Apple’s P/E ranged between 12.9 and 37.4 Apple’s PEG Ratio is currently 1.6 (based on ACE 18.9% growth and Projected PE of 30.2)

Considering the P/E Ratio Bed Bath & Beyond’s P/E is currently 17.6 S&P 500 average P/E is currently about 17.6 Dow Jones Specialty Retail industry average P/E is currently 6.1 Linens & Things current P/E is 36.3 In 2005, BBBY’s P/E ranged between 18.2 and 24.5 BBBY’s PEG is currently 0.9 (based on ACE 17% growth and Projected PE of 15.1)

What Will P/E Be in Future? Review historical annual average P/E Ratios to: Determine average P/E Determine signature P/E Determine future High P/E Ratio Determine future Low P/E Ratio

Determining Future P/E Ratios After eliminating outliers, Signature PE is 24.6 Average high PE ratio is 28, average low is 20

Considering Future P/E

Factors Affecting Future P/Es Do they fit expected future EPS growth? Do they fit with signature P/E? With experience, you learn how P/E Ratios behave in real world situations

The Hard Work Is Over! Once you have determined future High P/E & future EPS, you can calculate expected future high & low prices How? Back into P/E Ratio formula! High P/E x Projected EPS = Forecast High Price Low P/E x Low EPS = Forecast Low Price

One Final Step What’s the potential risk & reward from this investment? Make sure you have lots of upside compared to potential downside Upside: amount from current price to forecast high price Downside: amount from current price to forecast low price Will upside provide your desired total return? 15% Compounded Annual Return will double in 5 years

Congratulations! You’re on Your Way to Building Wealth!