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How to Analyze a Stock
By William Parmenter, Ph.D.,editor
W
ayne Thorp, CFA. talked on How to Analyze a Stockat the Oct. 20 meeting of the Los Angeles chapter of the AAII at the Skirball Center.
He is the editor of Computerized Investing, which is available to AAII members. Thorp is a senior financial analyst, who has been with AAII for 15 years.
Thorp talked for about two and one-half hours, taking the morning program. His talk comprised a discussion of the basic stock analysis process. He gave a guided walk through a company analysis, in this case Cummins (CMI), the world’s largest engine company.
Thorp explained DuPont analysis (ratio analysis), and dividend and earnings valuation models. Finally, he offered sources of company and industry data, via websites, investors can use in their own analysis.
His talk was a model for future AAII presenters, in that it was well organized, he followed his power-point presentation of slides, and his presentation was offered to the audience in the form of a 28-page handout. Thorp was a fluent and comprehensible speaker, who was willing to pause for questions.
Investors face the problem of too much choice with 10,000 companies on U.S. exchanges and internationally. Investors can
stock exchanges, and another 10,000 available
narrow their choice by using stock screening with AAII’s Stock Investor Pro, a Window’s based screening tool. For example, select a criterion of only selecting stocks that had 15 percent growth over the last five years.
Stock Screening
The Stock Screen area of AAII’s website is the most popular and is by far the most useful area of the website. It is available at It has “tremendous value,”Thorp said. The stock screening area allows you to tap into the methodologies and styles of 50 investment notables, with monthly updating.
Stock screening is just a starting point. After selecting likely stocks, individual stocks need to be identified for more intensive analysis. That analysis proceeds top down, by looking progressively at the economy (accounting for most of stock movements), the industry (AAII identifies ten), and the stock (the most promising stock in the industry).
The truism that stocks are affected by economic cycles, and the vagaries of events, make it essential to take the political-economy into account in any stock analysis.
The relationship between the stock and
its industry and, by extension, the political-economy, make the subject of new information sources a perennial hot button topic. Early accurate info (even illegal inside info) is the currency of the realm for opportunistic traders.
The five websites for hot and topical info, that Thorp shared with the audience was, by itself, worth the price of admission.
The five websites, that Thorp characterized as “very useful” are:
(focusing on the economy and its regions, giving current snapshots and prospective views).
(incisive economic analysis articles, monthly).
(Forbes take on trends and the economy).
(analysis of the economy).
Economic Cycle
Different asset classes outperform, depending where the economy is in its cycle. According to Merrill Lynch’s Investment ‘Clock’ the cycle and the outperformers are as follows:
In recovery: high-yield bonds, small caps, early cycle sectors, munis, and value stocks. In boom: commodities, overseas equities, late cycle sectors, TIPs and large caps.
In slowdown: short-term Treasuries, defensive sectors, high quality assets and long- term Treasuries.
According to IBD three major factors can create a rising stock price: a rising market (the most important factor), a rising sector, anda rising industry. IBD reports that approxi-mately 75 percent of stocks rise in a bull market
One of Thorp’s favorite websites is an excellent source of free stock, sector and industry charts. He likes point and figure charts, as they eliminate price noise. The toolbar at the stockcharts site contains a ‘chart school’ (for education), and a ‘market message’ (market info, but not forecasting).
It is well to remember that sector and industry typologies are not standardized, so you get different info with different providers, such as Morningstar, Yahoo, Thompson-Reuters, and at least three other popular sites. So, to avoid confusion, make a choice and stick with it.
Turning to AAII’s Stock Investor Pro, Thorp said there is not a better stock screener out there. Windows-based, it costs $198 per year, covers 2,200 stocks and is updated weekly, getting its info feed from Thompson-Reuters. To get started one can try the free version that AAII offers, updated on the 15th of the month. The data base contains seven years of cumulated data.
The next version of Stock Investor Pro, version 4.0 is forthcoming, and will allow daily updates.
Ratio Analysis
To illustrate single company investment analysis, Thorp singled out Cummins (CMI), the world’s largest engine company (whose major competitors are Caterpillar, Mercedes and Volvo). It is a bit of an economic bellwether, as its sales are linked to infrastructure projects.
Thorp discussed the DuPont method of earnings and growth analysis, developed by DuPont Co. to determine the factors affecting return on equity. The components of return on
equity (ROE) are: net profit margin, total asset turnover and leverage (an equity multiplier). The DuPont method illustrates the interaction between pricing, sales volume, and leverage.
The first ratio Thorp introduced was net profit margin, defined as net income divided by sales revenue. Using Stock Investor Pro tables in all illustrations, Thorp pointed out Cummins net profit margin improved over the last seven years, and was more than double the industry average.
The second ratio was return on total assets (ROA), defined as net profit margin times asset turnover. (Or, as net income divided by total assets). High profits link to low asset turnover; and contrarily, low profits link to high asset turnover. At Cummins ROA doubled in seven years, and Cummins’ ROA beat the industry by a factor of eight in three-, five- and seven-year periods.
The third ratio was leverage, or equity multiplier, defined as average total assets divided by average shareholder equity. Cummins leverage improved over seven years, and it was only about a third of that of the industry.
Thorp pointed out a little debt is good, but a lot of debt is very bad, because in an economic downturn, the company may go under, or require massive restructuring, as happened in the case of the company Cracker Barrel.
The last ratio was return on equity (ROE), defined as net income divided by average total shareholder’s equity. Cummins ROE over seven years fluctuated but overall increased, and was at least double the industry.
Thorp noted that valuations are important because it keeps the investor from overpaying for assets. But valuations are difficult to do. Stock valuations are a lot more art than science.
The investor needs to adjust to the reality of the market. Cummins now has short term headwinds, but it should rebound when the global economy improves. In 2011 Cummins brought in $18 billion in revenue, and initially forecast $20 billion in revenue in 2012, but had to revise it downward 15 percent to $17 billion.
Cummins is laying off workers and closing factories, reacting flexibly to a declining economy. Thorp concluded that Cummins is an excellent company, but now is not the time to buy it due to unfavorable market conditions, and more downside stock price potential than upside. Put Cummins on your watch list.
Additional Resources
Thorp’s handout included more sources for market data, company analysis and industry comparisons.
They include: This is the well known Reuters news service, reputed as one of the most authoritative, readable and concise. It is the service used by Fidelity, offering a brief summary daily, explaining the political-economic activityexplaining the context of financial index movements.
the service of MSN Money.
Morningstar’s service. Morningstar is a well-known and often used mutual fund analysis and rating service.
the service of the Standard and Poor, which produces the S&P 500, a gauge of 500 large cap companies in the U.S. economy, a bellwether for the economy, as it captures 75 percent of the value of U.S. equities.
is AAII’s Stock Investor Pro 4.0 (find out more at (800) 428-2244), priced at $198 per year, featuring weekly internet updates. Coverage is of 9,000 companies, with 2,000 data fields and 2,000 fields for screening.
Additional AAII investment resources include: investment e-books. Titles include: Investment Basics, Portfolio Building, and Stock Investing Strategies.
Thorp can be contacted at , and
Latest Innovations in ETFs
By William Parmenter, Ph.D.,editor
D
oug Fabian presented the Latest Innovations in the World of Exchange Traded Funds at the September 15 meeting of the Los Angeles Chapter of AAII at the Skirball Center. Fabian, well-known to the chapter, is the president of Fabian Wealth Strategies.
The development of ETFs has been rapid, with 1,300 products, capitalized at $1.2 trillion and over 30 ETF providers now available. More than 100 new ETFs were launched in 2012.
Fabian categorized available ETFs in 13 categories, including: indexed based, sector, fixed income, dividend, region specific, commodity, currency and multi-asset. The number of categories is an indication of the versatility of ETFs.
Among the recent innovations in ETFs have been: asset allocation, equal weight indexes, fund of funds, actively managed, and low volatility.
Top ETFs by Assets and Inflows
The top three ETFs by total assets are: SPY (S&P500) at $103.7 billion; GLD (gold) at $65.7 billion; and VWO (Vanguard Emerging Markets) at $50.6 billion.
The top three ETFs by 2012 inflows are: VWO (Vanguard Emerging Markets) at $7.4 billion; LQD (iShares Investment Grade Corporate Bond) at $4.9 billion; and HYG (iShares High Yield Corporate Bond) at $3.7 billion. Dividends are currently a popular investment theme. VIG (Vanguard Dividend Appreciation) brought in $1.8 billion year to date.
Among bond ETFs BOND, Pimco’s Total Return is a clear winner, with $2.9 billion in assets, since its launch at the first of March, 2012. Since then it has gone from a base of 100 to 108, which is an increase of about 10 percent, with a very smooth up slope.It is an aggregate bond ETF with 737 holdings, and an expense ratio of .55 percent.
Fabian reviewed a number of other promising ETFs. Their ticker symbols were:
IYLD (asset allocation) with a yield of 5.28 percent; AMLD (energy sector) with a yield of 6.18 percent; CVY (asset allocation, income) with a yield of 5.46 percent; SPLV (large cap equity), with a yield of 2.95 percent.
RJA (agricultural commodity pool) with an expense ratio of .75 percent; MOO (agricultural stocks) with 48 securities and an expense ratio of .53 percent; IEZ (energy) with an up and down price curve that has fluctuated between $59 in March, $43 in June and back up to $55 in September, 2012; EWS (Singapore, single country) that has appreciated over 25 percent in 2012; and GDXJ (gold mining stocks) that has disappointed in 2012 by dropping in price from $26 to $24.
The Fabian Top Five
Fabian’s top five ETFs for income, in a low-interest rate economy, where retirees are starved for income, are: DEM, BOND, IYLD, CVY and SPLV.
For those willing to take a flier on growth in a choppy market trending downward due to multiple stiff headwinds, Fabian has top five ETFs for growth: VWO, GLD, QQQ, IEZ and MOO.
For a complete list of ETFs, go to Fabian’s website at:
Fabian’s trading tips for ETF investors were to be thoughtful and cautious about: position size, volume, price history and sell orders.
For an ETF report, which Fabian calls “the ultimate income strategy report” check out his Monday morning podcast, free at By now it should be clear how to contact Fabian for more information and queries, yes, go to
SoCal Real Estate Opportunities
By William Parmenter, Ph.D.,editor
T
odd Rubinstein presented on the opportunities available for the small investor in real estate at the Sept. 15 meeting of the Los Angeles AAII chapter at the Skirball Center. He is a senior partner of the Rubenstein Group at Told Partners.
The goals of his talk was to: help investors diversify their portfolios, to explain types of real estate, to review market trends and statistics. Further, he explained acquisition and investment analysis, pointed out pitfalls and common misperceptions, and commented on sourcing properties and opportunities.
Re diversifying, according to Rubenstein, 15 to 25 percent of your portfolio should be in real estate. That will improve your return on investment, and provide monthly income and an increase in equity.
Five Kinds of Real Estate Investments
Rubinstein identified five different kinds of real estate investments: 1) commercial, 2) single family, 3) residential income with two to four units, 4) apartment houses with five or more units, and 5) notes, mortgages and trust deeds.
The advantages of investing in apartment houses are well appreciated by investors. The advantages include: retirement income, economies of scale, and that increases in property value are not needed to generate a positive cash flow. Rents cover expenses, taxes and mortgage payments. Depreciation gives a tax advantage. Paying down the principal, and appreciation increases equity.
On apartment houses in Los Angeles the asking price declined between 2008 and 2012, when it bumped up. Between 2010 and 2012the sale price of apartment houses declined 17 percent, and then bounced up a little.
The 30-year fixed mortgage rate dropped from 6.2 percent in 2008 to a little under 4 percent in 2012. Meantime the 10-year Treasury note yield dropped from 4.7 percent to 1.8 percent. These trends tended to push money into real estate investments, as the cost of borrowing declined by 37 percent, and the yield on the 10-year note dropped 62 percent.
The attractive buying opportunity for real estate is highlighted by a 30-year fixed mortgage rate at 3.55 percent, just above the record low of 3.49 percent attained in July.
Comparing rates, the Federal Funds rate has been at near zero since March, 2009, while currently the 15-year mortgage rate is 1.8 percent, and the 30-year mortgage rate is 1.6 percent.
Vacancy, absorption and completion rates are all running at about 4 percent. The cap rate has been falling since the third quarter of 2009, and now stands at 6.3 percent, inching its way down to historic low rates last observed in 2007.
What are some other reasons to make investing in real estate attractive now? They would include: decreasing vacancy rates, increasing rental rates, a decrease in the homeownership rate, baby boomers are retiring, and GenY is avoiding homeownership.
Acquisition Criteria
Criteria for acquisition include location and condition of the property, return on investment, the cost of initial investment and financing, and going through the investment analysis.
To illustrate purchase costs and returns Rubenstein ran through several examples. Figures are appropriate for today’s market.
Example one, a short sale with a seller owned short payoff (pending escrow) of a Los Angeles property of 2,100 square feet with four units. Purchase price $245,000; down payment, 25 percent, i.e. $61,250; estimate of closing cost, $5,513; total cash investment $66,763; amount financed, $183,750; interest rate, 4.5 percent; loan term, 30 due in 10 years; monthly payment $981; gross rate multiplier, 7.04; net operating income, $21,024; capitalization rate (income producing rate of the property), 8.95 percent; return on investment, $10,154; cash on cash return after debt, 16.58 percent.
Example two, a developer owned active, standard sale of a Sherman Oaks 7 unit building with 10,760 square feet. The purchase price: $2.2 million with a 25 percent down payment of $550,000. Closing cost estimate of $27,500. It was financed with a new loan, $1.65 million at 4.5 percent interest rate. The net operating income was $102,960, with a cap rate of 5.15 percent (broker states 4.8 percent). Return on investment of $2,636. (See the slides on the website, presenters slides for more details and examples of purchases.)
All-to-Common Pitfalls
Some common pitfalls are poor acquisition strategy, faulty investment analysis and poor management skills. More pitfalls include: a bad location, bad purchase timing and lack of analysis (eg. High entry and exit price). Also, inappropriate financing, and poor understanding of the risk versus reward possibilities. More pitfalls include an incoherent strategy; no budget for contingencies, rehabbing or repositioning; following bad advice and having an incompetent team.
Property management issues include tenant screening, regular property checks, leasing and resident retention, following proper eviction procedures, competent accounting, rent control and the three Ts (tenants, toilets and trouble).
Other management issues are: self-management; on-site management (required for 16 or more units under Calfornia law CCR Title 25, section 42), and off-site management via a property management company.
Slide 35 would be of interest for its list of 18 websites, including those of Zillow ( the investors guide to private money lending, Fannie and Freddie Mae, the national apartment association, and, many others.
If readers want a copy of the 36-slide presentation, in the first instance, they can read it and download it off the chapter website, under presenter’s slides, at In the second instance, they can query Todd Rubinstein, and get the slide presentation, a glossary of commercial real estate terms, and the apartment outlook reports for 2012, at , or at .
Market Psychology
Edited by Mark Skousen, Ph.D.
T
hanks to professor Mark Skousen, a speaker to the L.A. AAII chapter, who donated a copy of his book, The Maxims of Wall Street (2012), we can share with you a few aphorisms on market psychology: