Here's one from Kevin in St. Peter, Minnesota. As a reminder, Homework posts aren't intended to be stock picks -- they're examples of the Rule in action. This particular post gets into why it's important to come up with your own growth rate in addition to looking at what the analysts think.
Hello Phil Town,
I just finished reading your book (I devoured it in under two days!) and am hoping to use The Rule #1 to help my wife and I be able to retire early (I'm 33, she's 32). I am planning on doing some paper trading for a bit first, and I went to Investopedia.com to open an account for practice. The first thing I did was buy 1000 shares of eBay, just for a test.
I then figured I should put eBay through the ringer. Here goes:
Meaning: I've been using eBay for years, and teach community ed classes on how to buy and sell on eBay.
Moat: I believe that eBay definitely has a Brand Moat, and possibly a Switching Moat as well -- once you're established on eBay you have a high "Feedback Rating", going to a new site would reduce the years of goodwill that you've accumulated.
Management: Pierre Omidyar is the Founder of eBay, and is also Chairman of the Board. The CEO is Meg Whitman, who joined the company in 1998 when it consisted of 30 employees. She has overseen the growth of eBay from a "Beanie Baby swap meet" to a global force that sells big revenue items like cars, houses and islands.
Margin of Safety: I ran the numbers on eBay, and here's the Big Five numbers:
ROIC Equity EPS Sales Free Cash 5 1 7 5 3 1 6 5 3 1 8 5 3 1 4 3 1 9.9 10.8 87 50 36 42 107 81 55 37 131 60 55 39 Err:523 -256 2310
The growth rates are dropping, but they were at absurd levels to begin with. The Free Cash numbers are all over the place. In 2005, eBay purchased a number of companies to expand their marketplace idea, including Shopping.com and Rent.com.
I picked a future PE of 60, which works with the industry analyst's prediction of 30% growth rate. Continuing the math:
- Future EPS: $10.75
- Future Stock Price: $645.18
- Sticker Price: $159.48
- MOS: $79.74
eBay is currently selling at $39.06.
Gosh, that looks good. OK, assuming I've done all that correctly, I need to check the charts.
The 8-17-9 MACD showed a buy on 3/28.
The 10-day Moving Average showed a buy on 3/28.
The 50-day Moving Average does NOT show a buy.
The 14-5 Slow Stochastic showed a buy on 3/28.
The 14-5 Fast Stochastic showed a buy on 3/28.
Thanks in advance for any help on this. I loved your book, and have read a ton of your blog entries. There's still a part of me that follows the adage "if it sounds too good to be true, it probably is." So I'm going to do some paper trading to convince myself that what you say works.
A new loyal fan,
Here's my response:
Nice job on Ebay Kevin. I like it and I buy it. But let's check the MOS (you did a really nice job on the rest of it.)
It's important not only to check the analysts estimate but to make our own, and EBAY is a great example of why that is.
In January last year, Meg got on a call with the analysts and explained that there was no way the biz was going to keep growing at 40% a year. She thought maybe 19% was a good sustainable long term number. The stock dropped 30% overnight on the news.
I got red-arrowed outta there about 10 days earlier, so the word was out that the theater might be on fire and some of the big guys were leaving the building days before the general panic set in. Love those arrows.
If you look at the actual numbers on Zacks you'll see that the range of expectations for 9 analysts goes from a low of 22% to a high of 45% -- so nobody believed her. They all think she's lowballing to get expectations down a bit and get the pressure off. Likely they are right.
But what is the right number? There is nothing illogical about using the 30% average since historical projections are all higher than that. Still, the CEO isn't stupid and 30% is a very high growth rate to sustain. I'm feeling 25% -ish here. That and a Rule #1 PE of 50 would put this thing at a Sticker of $90, and at the current price of $39 we still have a huge MOS.
But here's the point: the market doesn't believe their own analysts or the history of the business. The market believes Meg and is pricing the business accordingly.
Isn't that interesting? Plug in a 19% growth rate and the Rule #1 PE of 38 and you get a $41 Sticker. Close enough for government work.
Except that since she chatted up the institutional guys and scared the whatever out of them, her EPS didn't grow at 19%. It grew at double that.
Oh yeah and Sales also grew at almost 40%, and so did book value per share (Equity). So if you're an analyst and your job is to predict where a business is going to be in five years you'd look pretty stupid projecting 19% while the thing is growing across the board at $38%, wouldn't you? Yet the fund managers can't quite shake off what she said.
And there-in lies the joy of Rule #1 investing. We can shake it off because we can get out in a hurry if she turns out not to have been low balling the numbers. We can invest with a great MOS if the growth is 40% lower than it is right now. We can do this because we are little and for the first time in history the little guy has an advantage.
So I'm with you, bro. This thing looks undervalued to me. It's a great company run by people who have a huge BAG and are honest and owner-oriented. You are in the business that you want to buy. It's got a HUGE moat. The Big Five just don't hardly look better and the MOS is huge even with scaled down numbers.
And be aware that no matter how wonderful the biz, no matter how cheap the price, if the institutional guys pull out of here, this thing can go down 50% overnight. So watch the arrows and sleep well at night.
Now go play.