1. Portfolio Management Workshop 1999 Online Workshop By Ellis Traub

2. Read the Original at: http://old.better- investing.org/educate/portmgt/pm1.html

3. Suggested Readings NAIC Official Guide Take Stock, the book, by Ellis Traub Toolkit 4.0 Manual

4. Portfolio Management PM begins with stock selection The use of NAIC PM tools assumes you have selected stocks with the SSG Do a new SSG for any stock in the portfolio if you are not sure.

5. The SSG Overview Ask Two PROGRESSIVE questions of your candidate Is this a QUALITY Company (Quality = Growth + Efficiency) Growth in the Visual analysis, section 1 Upward trending, smooth, parallel data lines Growth appropriate for company size Recent growth in line with historic growth Efficiency in Section 2 (Return on sales and equity) Even or up trends in sections 2A & 2B Values at or above industry/peer averages IF, AND ONLY IF this is a QUALITY company, is the current price at a level we have a fair chance of doubling our money in 5 years with minimal risk? (Risk vs. Reward) B.U.R.T. Reward In the “B.uy Zone” Risk U.pside/downside ratio 3:1 or more e.g. 4:1, 5:1 R.elative Value 85% to 110% Reward T.otal Return 15% compounded - Doubles money in 5 years

6. Barbed Wire Fence You ONLY ask the valuation question IF the answer is YES to the quality question!!! Don’t buy junk at any price!! The worse a stock performs, the better value it appears to be! Always, Always buy quality!!

7. What does QUALITY look like?

8. Growth Stocks Visual Analysis Look for This!! Remember: U S Post office Upward trend Smooth Parallel

9. Not This… Downward trend Non Smooth Non Parallel

10. Real Life Examples

11. This portfolio assumes you have used the SSG to chose stocks with “Monotonous Growth”. It further assumes you have not done anything since.

12. Biomet

13. Cisco

14. Clayton Homes

15. Merck

16. Forest Labs Monotonous Whoops!

17. You should be seeing problems in the SSG’s! Forest Labs used to be a monotonous grower. PM would have caught this long ago.

18. PORTFIOLIO MANAGEMENT

19. Goals Build a portfolio of QUALITY stocks that doubles in value every 5 years - 15% CAGR Not every stock must return 15%, but the overall average should be 15% Diversify across Sectors and Size of Sales Don’t have to own all sectors – e.g. utilities SML 12 to 20 stocks – Sweet 16 +/- 4 What you can follow

20. Portfolio Management Two Platoon Game… Defense Rule of Five.. Catch the bad one Diversification.. Overgrowth % Offense Lock in profits from grossly over valued stocks.

21. Meet the Players PERT Worksheet A PERT Worksheet B PERT Report PERT Trend Report PERT Summary Report PMG Challenger

22. Check Profit Margins Check RV < 85

23. Update Data & Price Simple with OPS! Done monthly for price Done quarterly for data

24. Modify SSG Judgments Save a copy of your original SSG Use: Save as… msft-o.ssg Modify previous judgments if conditions have changed and warrant it.

25. PERT Defensive Elements

26. Growth Benchmark Taken from your estimate of eps growth on side one of the SSG Since we limit eps growth to no more than sales growth, use as benchmark for sales, PTP, & eps. Ralph Seger recommends using analyst’s one year growth rates which can be entered in the ToolKit data entry box.

27. What Do I Look For? Rank by PreTax Profit Sales growth Declined from last year? In line with your projection with eps growth? Declines are not trivial - Top Line Growth Pre-Tax Profit Compare % change with eps growth rate Not easy to hide problems here vs. eps Earnings Use Q/Q & TTM data Compare to Estimated eps growth rate

28. Why did we buy such a slow grower?

29. Sales Sales are “TOP LINE GROWTH” Slowing sales can mean maturing company Everything else (PTP & eps)comes from sales Slowing sales means slowing PTP and EPS

31. Pre-Tax Profit Problems can show up here first It’s hard to hide problems here. They can manipulate taxes and # of shares to help eps, but not PTP Declines here with growing sales means shrinking profit margins and problems with management’s handling of expenses. Section 2A SSG

33. EPS – The Bottom Line If sales and PTP are OK and eps declines, look for changes in taxes or shares. Remember, the stock’s price generally follows the EPS, but eps can’t grow faster than sales and PTP for long.

34. Harbinger - RV Webster: A person or thing that comes before to announce what follows. Check the Relative Value If it is below 85, ask your self: What does the market knows that I don’t? Why are investors unwilling to pay their historical price for a dollar of the company’s earnings? Is there a fundamental reason?

35. You Have a Red Flag! When to Sell You want or need the money A stock is grossly over valued Lots of risk – little potential reward Diversification – Rebalance Portfolio Fundamentals have changed adverse management declining profit margins deteriorating financials effective competition single product becoming obsolete change because of economic conditions becoming cyclical

36. Problems with the Fundamentals

37. Bad Quarters are like cockroaches.. You seldom find just one. But cockroaches hide so how do you find them?

38. PERT Trend Report

39. So What’s Up With Forrest Labs?

40. Devil is in the Details PERT Worksheet A On the left side of the form, the % changes are recorded for each quarter as compared with the same quarter the year before. As you can see the numbers are all over the lot on the left section.

41. Devil is in the Details PERT Worksheet A On the right side of the form you will find the sum of the trailing four quarters, for each quarter and the % change between that and the same period the year before. Trends are easier to identify because the data is smoothed by using the moving sum of the trailing data. Forest has seen bad times. Sales began to decline 1Q 96 and only within the last 5 quarters have they picked up again. You’ll see this clearly on the graph we’ll discuss next.

42. See the decline See the increase

43. Again, see the decline and then increase, smoothed with the rolling 4 quarters data

44. Who Ya Gonna Call? Access the web by clicking the little blue “W” button and going to the company’s web site.

45. The Moral If you were minding the store as you are now, you would have been out of it long ago. If you’re still in it, you probably shouldn’t be! Sell Forest Labs! (Remember this was 1999)

46. Defense & Offense Defense is urgent. If you don’t take action you can get hurt. Offensive is less likely to involve pain from not taking action, but is an important part of portfolio management if you are to be a winner.

47. Offensive Management Authority from Challenge Tree chapter NAIC Official Guide: Starting and Running a Profitable Investment Club. When you find a stock has passed the point where it has greater risk than reward, replace it with one of equal or better quality. If you can’t find a company that meets those criteria – 3:1 US/DS, 15% TR- consider putting 20% of the most speculative part of the portfolio into good quality bonds. Wait until the market makes stocks attractive again.

48. Offense with PERT PERT has a dual function. We’ve already seen its function of monitoring recent fundamentals. Now we’ll look at the left side which deals with value. Just as we observed with the SSG, NEVER consider value until you are sure you have a quality stock.

49. Offense with PERT Remember, the worse a stock performs, the better value it appears to be. Don’t buy junk at any price. You’ve already checked quality with the SSG and PERT & PERT Worksheet A at this point and sold Forest Labs. Move onto valuation for the other four!

50. Offense with PERT The right side deals with value. We are interested in RV, US/DS ratio, & compounded rate of return.

51. What Offends me? Risk RV > 150% US/DS < 1:1 e.g. 0.3:1 or -0.0 Reward Total Return or PAR < 15%

52. Relative Value After looking at the fundamentals, only Forest Labs revealed problems. Inspecting RV shows only Clayton homes near our RV zone of 85 to 150%. Above 150% suggests we should consider selling, at least, a portion of the holding. Below 85% suggests we should re examine the fundamentals for something missed. Biomet approaches the 150% line and the others are well over the line.

53. Risk & Reward Moving a couple of columns to the right, Clayton Homes is the only holding with more potential reward than risk. (US/DS > 1:1) Biomet & Merck have an US/DS of 0.3:1 or the reverse of 3:1. …3 times the risk of loss to gain! Cisco is at -0.0 tells us the current price is above the forecast 5 year high price.

54. Risk & Reward Only Clayton Homes is above the 15% area we look for. Biomet & Merck, although great companies, have limited upside potential with 3.5% & 5% resp. If Cisco were priced at your estimated high price in five years, you would LOSE money! The bottom three need serious offensive consideration!

55. What Will You Do? The next step depends on the cost of trading. If this is in a tax deferred account with $12 trades there would be little question of replacing Biomet & Merk. We should sell Cisco outright because we could make more in a money market with little or no risk. In other accounts trading costs and taxes must be factored into the decision.

56. Challenger The Challenger aids you in making this decision. It has two views. Here is the first, the numerical view. Lets you compare quality.

57. Challenger Here is the second, the graphical view. Where the lines cross is the projected “break even” point. The less time to break even, the better the decision.

58. Guidelines From the book, Take Stock, by Ellis Traub US/DS > 1:1 1:1 - 0.3:1 <0.3:1

59. Percentage of Portfolio One reason to sell was to protect diversification. You should own between 12 and 20 stocks –( Sweet 16 + or - 4) so no stock should be more than 5% to 8% With this 5 stock example, 20% is the max. You can see that even IF Cisco and Merck had significant return potential, they have become such a large percentage, some should be sold.

60. NAIC The Big Picture

61. Universe of Stocks SSG PERT Worksheet A Quality, Value - BuysQuality, NON Value WatchesNON Quality, Discards NAIC Prospector SCG PortfolioPounce Pile Portfolio Management Of Purchases & Pounce Pile

62. Pert Report PERT Trend Report PERT Worksheet A No ProblemsProblems Monthly price update Quarterly Data & Judgment Investigate w/ 10Q,10K & news articles Portfolio Management Of purchases & pounce pile Temporary Problem Re evaluate next quarter Sell No Problems

63. Portfolio Management Of Purchases & Pounce Pile Valuation of Quality Stocks with PERT Use RV, US/DS, TR BUY HOLD RV >150, US/DS < 1:1, TR < 10% Opportunity to add to positions Offensive Management Challenger RV 85 – 110 US/DS > 3:1 TR ~ 15% REPLACE? RV 85 – 150 US/DS >1:1,< 3:1 TR ~ 15%

64. The End!