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

2. 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

3. 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

4. Why Invest in Stocks?

5. 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

6. 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

7. 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

8. 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

9. Typical Trading Chart

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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.”

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

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

19. 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

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

21. How About This?
Bed Bath & Beyond

22. 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!

23. Are These Margins Stable?
AT&T

24. And How About These?
BBBY

25. 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

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

27. How About This?
Bed Bath & Beyond

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

29. Estimating Future Growth

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

31. 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

32. 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

33. 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)

34. 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)

35. 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

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

37. Considering Future P/E

38. 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

39. 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

40. 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

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