1. Smashing BI Myths Cy Lynch Classes-To-Go

2. BETTERINVESTING NATIONAL CONVENTION Disclaimer The information in this presentation is for educational purposes only and is not intended to be a recommendation to purchase or sell any of the stocks, mutual funds, or other securities that may be referenced. The securities of companies referenced or featured in the seminar materials are for illustrative purposes only and are not to be considered endorsed or recommended for purchase or sale by BetterInvesting™ National Association of Investors Corporation (“BI”) or the BetterInvesting Volunteer Advisory Board, its volunteer advisory board (“BIVAB”). The views expressed are those of the instructors, commentators, guests and participants, as the case may be, and do not necessarily represent those of BetterInvesting™ or BIVAB. Investors should conduct their own review and analysis of any company of interest before making an investment decision. Securities discussed may be held by the instructors in their own personal portfolios or in those of their clients. BI presenters and volunteers are held to a strict code of conduct that precludes benefiting financially from educational presentations or public activities via any BetterInvesting programs, events and/or educational sessions in which they participate. Any violation is strictly prohibited and should be reported to the President of BetterInvesting or the Manager of Volunteer Relations.

3. BETTERINVESTING NATIONAL CONVENTION Overview Myth: Something widely believed, but false (or at least unsupportable) Just because something’s oft repeated, doesn’t make it so Hopefully, this session will unsettle you a bit, shake your assumptions and provoke thought

4. BETTERINVESTING NATIONAL CONVENTION The Big Three The “Preferred Procedure is “Too Hard” to mess withThe “Preferred Procedure is “Too Hard” to mess with The upside/downside (U/D) ratio properly measures risk in buying a stockThe upside/downside (U/D) ratio properly measures risk in buying a stock Don’t buy a stock whose P/E ratio is more than one to one and one- half its growth rate (PEG > 1 - 1.5)Don’t buy a stock whose P/E ratio is more than one to one and one- half its growth rate (PEG > 1 - 1.5)

5. BETTERINVESTING NATIONAL CONVENTION BI Myth #1 The “Preferred Procedure is “Too Hard” to mess withThe “Preferred Procedure is “Too Hard” to mess with –Not sacrosanct, some truly disagree, but very widely held –Largely a result of misunderstanding what’s going on with all methods of projecting future EPS

6. BETTERINVESTING NATIONAL CONVENTION Remember, our ultimate goal is to project potential high EPS figure in five years, not a growth rate Three broad ways to do this: –Applying a projected EPS rate of increase to historical results (probably most common) –Preferred Procedure (based on projected sales growth) –Use analyst projections BI Myth #1

7. BETTERINVESTING NATIONAL CONVENTION Preferred Procedure involves four judgments: –Projected total sales/revenues five years out –Projected pre-tax profit margin in five years –Projected income tax rate five years out –Projected shares in five years BI Myth #1

8. BETTERINVESTING NATIONAL CONVENTION Preferred Procedure involves four judgments And results in “Expected Income Statement” BI Myth #1

9. BETTERINVESTING NATIONAL CONVENTION Four judgments Expected Income Statement 1 2 3 4 BI Myth #1

10. BETTERINVESTING NATIONAL CONVENTION “Graphical” Expected Income Statement Same four judgments 16,300.0 1 2 3 & 4 BI Myth #1

11. BETTERINVESTING NATIONAL CONVENTION Some reasons given not to use the Preferred Procedure: –“Too many ‘guesses’ ” But all methods require projecting sales growth, profitability, taxes and shares (preceding slide) Would you rather do it “implicitly” (blindly) or “explicitly” (intentionally) BI Myth #1

12. BETTERINVESTING NATIONAL CONVENTION Some reasons given not to use the Preferred Procedure: –“It results in projected EPS being too ‘low’ ” Usually caused simply by using “defaults” – projecting current into future Could be a good reason to use the Preferred Procedure BI Myth #1

13. BETTERINVESTING NATIONAL CONVENTION Other considerations: –Historical sales often more consistent than EPS Thus growth rate can be easier to project –Where do you start the EPS future trend line? Last fiscal year (usual method), last fiscal quarter or end of historical trend line? –It’s really not “harder,” just a little more detailed BI Myth #1

14. BETTERINVESTING NATIONAL CONVENTION And realize… The “Preferred Procedure” really was preferred “Usually it is better to estimate EPS five years in the future by applying profit and tax margins to the projected sales five years in the future rather than by drawing an EPS trend line.” [emphasis added] – George Nicholson, NAIC Investors Manual, 1 st Edition (1984), page 53. BI Myth #1

15. BETTERINVESTING NATIONAL CONVENTION The upside/downside (U/D) ratio properly measures risk in buying a stockThe upside/downside (U/D) ratio properly measures risk in buying a stock –First, volatility isn’t risk –Second, U/D ratio doesn’t take into account dividend payments Thus, useless in comparing stocks with different dividend yields BI Myth #2

16. BETTERINVESTING NATIONAL CONVENTION The upside/downside (U/D) ratio properly measures risk in buying a stockThe upside/downside (U/D) ratio properly measures risk in buying a stock –Finally, you can’t rationally quantify market irrationality on either high (exuberant) or low (pessimistic) end Just how well have your projected low prices held up this past year? BI Myth #2

17. BETTERINVESTING NATIONAL CONVENTION Corollary: –Zoning based on low price as well –Same problem with rationally projecting irrationality –Omission of dividends can impact as well BI Myth #2A

18. BETTERINVESTING NATIONAL CONVENTION Don’t buy a stock whose P/E ratio is more than one to one and one- half its growth rate (PEG > 1 - 1.5)Don’t buy a stock whose P/E ratio is more than one to one and one- half its growth rate (PEG > 1 - 1.5) –Many examples disprove validity of “one-size fits all” rule –The “one-size fits all” rule fails statistically, too BI Myth #3

19. BETTERINVESTING NATIONAL CONVENTION The reality: –P/Es vary by industry (numerator of PEG ratio) –Growth rates vary by industry (denominator of PEG ratio) –Some stocks never sell for PEG < 1.5 3M (sells for PEG between 1.9 and 3+) Procter & Gamble (PEG between 1.3 and 2.5) (even higher before Gillette acquisition accelerated EPS growth) JNJ came close only once in past 10 yrs. So you would never buy them BI Myth #3

20. BETTERINVESTING NATIONAL CONVENTION The reality: –Stocks with flat or declining EPS for extended periods still have a positive P/E General Motors (GM) Ford (F) Tootsie Roll (TR) Liberty Property Trust (LRY) Plum Creek Timber (PCL) Embarq Corp. (EQ) Cincinnati Bell (CBB) –P/E should be zero if one-size really fit all BI Myth #3

21. BETTERINVESTING NATIONAL CONVENTION Compare Tootsie Roll’s EPS history… BI Myth #3

22. BETTERINVESTING NATIONAL CONVENTION … Its P/E history BI Myth #3

23. BETTERINVESTING NATIONAL CONVENTION For one-size fits all rule to be statistically valid: –The trend line would have a slope of 1 –It would intercept the vertical axis at 0 –Shown by dotted green line But actual trend line (in red) does neither BI Myth #3

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