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Author: TMFGebinr Big gold star, 5000 posts Top Recommended Fools Old School Fool Supernova Phoenix 1
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Subject: BMW FAQ Date: 3/24/2006 7:51 AM
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BMW Method FAQ

Welcome to the BMW Method board, a place to hang out, discuss the mechanics of this method, talk about potential “BMW” stocks, and follow a portfolio based upon this method.

1. What is the BMW Method?
This is a method for picking under-valued stocks developed by BuildMWell several years ago after noting the exponential type growth of the market overall and many stocks in particular. It is based on reviewing the exponential growth of a company's stock price from some point in the past (usually 20 – 30 years) and comparing today's price to ranges of growth rates (CAGR) that have defined that company. A stock that is at or below its lowest historical CAGR rate is considered a good buy.

The method was first described on the Foolish Collective board, and then was moved to this board, created specifically for the BMW method. So don't be surprised if some of these links take you elsewhere within Fooldom.

<http://boards.fool.com/Message.asp?mid=20281104&sort=whole> The description for it as described by BuildMWell.
<http://boards.fool.com/Message.asp?mid=20284814> Discussion of CSCO as an example of a BMW stock by BuildMWell.
<http://boards.fool.com/Message.asp?mid=20287940> Discussion of JNJ as an example of a BMW stock by BuildMWell
<http://boards.fool.com/Message.asp?mid=20976803> Look at the DJIA which started it all


2. What is the basic principle of the BMW Method? Is there any real logic to it?
As answered by BuildMWell:
In my opinion, anyone entering the world of investments should understand why they are investing in the first place. Obviously, it is to increase their net worth through appreciation of value, but why would one invest in equities? Why not just put money into a savings account? A savings account guarantees you a compound annual growth rate (CAGR). The basic premise of the BMW Method is that a stock can do that too. But, most people never look at it like we do here. We actually look at a stock just as if it were a savings account.

Many people will tell you that the stock market is "risky" and that you might lose money in the markets. And, that is true. But, on average, it is totally false. In the past 100 years, the market has yielded a compound annual growth rate of 5% (not including dividends). That includes the Depression, the "Crash of 1987" and the recent "Bubble." Even with those set-backs, the market, as a whole, has done quite well.

During that time, we have had numerous recessions and booms. But, the Dow Jones Industrial Average has still yielded 5% over the whole time. Please look at the linked charts below. You will see the entire past century displayed for you on one set of charts. That one CAGR curve shows that from 1900 to the present, the Dow Jones average has grown at almost exactly 5%. On top of that, the Dow Jones Average includes stocks that pay a decent dividend, thus the total return is much better than 5% . . . more like 7% to 8%. That surely beats any savings account that I know of. And, that is just the average! We should be able to do far better than "just average".

<http://personal.palouse.net/muellerj/FCExcel/BMW-DJIA.html> Several views of the DJIA

If you will take some time and review the figures in the link above, the overall picture should start to emerge for you. In fact, you might consider printing it out and studying it in detail. There is much to absorb. The real question is, "What is the compounded return on the Dow?" The graph answers that question. The good news is that the growth rate is increasing. The 100 year CAGR is 5%, the 60 year is about 7.5% and the last 24 year's CAGR is 13.3%. I do not believe that we can expect 13% growth forever, but 24 years at that rate says this country of ours has great potential to continue growing.

First, ask yourself if the BMW Theory makes any real sense? Why should the market cycle around the present DJIA average? Is the market static or is it dynamic? I say it is absolutely dynamic! So, by charting lines of constant CAGR, the past history begins to make much more sense. The effects of the "Great Society", runaway inflation, and uncontrolled government spending, begin to look very clear as to how they affect the market. Likewise, the 1981 tax reductions, the 1994 balancing of the budget and other market friendly actions also spring out as the market tells us what it likes and what it dislikes.

The past 24 years is exposed as not so much of a bubble but as a revolt against bad decision making in the past. Surely it was overdone, but by how much? The DJIA 30 is the broadest index and represents the largest business influences in America. In my opinion, the DOW has actually come through the bubble remarkably well. In fact, I might ask, "What bubble?"

This is the "Big Picture" that we, as investors, need to have in the back of our minds as we approach the "art" of investing. If we can see the big picture, we know what to expect in the long run. Also, knowing that the DJIA is just an index that includes 30 stocks, we can then begin to see that most stocks have definite trends that repeat over time. Just like the overall markets, the individual stocks inside of an index seek new highs and new lows over time. If we merely spot the lows and buy then, we optimize our returns. We can "beat the averages." That, in a nutshell, is the BMW Theory. The BMW Method is the implementation of that theory. But, first, you must make sure that the Theory makes sense to you. If it does, just keep on reading. There is much here to help an investor.

< http://boards.fool.com/Message.asp?mid=20990782> Further discussion of the approach including diversification.


3. How does it work?
Once you have a company's historical prices going back for up to 30 years or so, an exponential growth curve, called a CAGR line, is calculated and plotted onto the plot of historical prices. The idea is to compare the current CAGR line to other CAGR lines and therefore compare today's price to what the stock has done historically.

CAGR stands for Compounded Annual Growth Rate and is calculated by the following expression:
          CAGR = ([Today's price] / [Starting price] ) ^ (1 / # years) - 1
This gives a percentage that the starting price would have to grow at each and every year to reach today's price. For example, if today's price is $60 and the price 3 years ago was $30, then the CAGR would be
          CAGR = (60 / 30)^(1/3) – 1
CAGR = 0.259921 or 26%
In other words, today's price is what you would get if you increased the price at the end of each year by 26%.
          30.00 x 1.26 = 37.80  end of 1st year
37.80 x 1.26 = 47.62 end of 2nd year
47.62 x 1.26 = 60.00 end of 3rd year

The same equation can be used to assign a particular CAGR and see where the stock price would be today given a particular starting price. By choosing different CAGR values, the investor can see how a company's stock price history has behaved compared to a smoothly growing exponential curve (any of the CAGR curves).

The idea behind selecting a stock to buy is for the current price to be at or below the historically low CAGR line. Start off with buying a few shares and put in a limit order to buy more at a lower price. Rinse and repeat. For example 100 sh at $14, 200 sh at $13, 400 sh at $12. Then when the price climbs back up and approaches the historically high CAGR line, sell the stock. Hopefully in this manner, one can buy when a stock is low and sell when it is high.

For those who wish to run a quick calculation, here is an on-line CAGR calculator:
< http://www.moneychimp.com/calculator/discount_rate_calculator.htm>


4. Sounds pretty straight forward, but what's the point?
The point is to bracket the majority of the company's stock price history within a set of CAGR lines. Start off with 20-30 years' worth of price history. Then draw the current CAGR line through the actual stock price data, starting at the beginning of the price history and ending at today's price. Is this above or below what appears to be the average? Select some different CAGR rates and draw a series of rate lines which are representative of the areas where the stock price has actually wandered. At a minimum, draw one that passes through or near the stock price that would represent the lowest growth rate the company has seen, one near or through the stock price for the highest growth rate, and one that seems to be about average. It is helpful to have several intermediate lines that split the difference.

Some judgment comes into play here. For instance, if there was a stock market crash, maybe that data should not define the Low CAGR line. The Low CAGR line defines what a historically good price is and is a signal in the BMW Method to start considering a buy. Unless you intend to hold out for stock market crashes and only buy then, you might be better off selecting a Low CAGR line that passes through the lowest low in a normal business environment. Just annotate your chart "Stock crash", and plot right on through.

The High CAGR line defines the highest price which you expect the company to reach by showing the highest CAGR the stock has visited in the past. Just as a crash should not be used to define the Low CAGR, a stock market bubble is probably not what one should set one's hopes on for a sell price. So, we should define a High CAGR that lops off any bubbles somewhat.

All of this refining and plotting is doable by hand (ask BMW!), but is probably easier using an automated spreadsheet like zach's or gebin's (see links below) that will allow you to try with actual values. Give yourself a bit of practice using different lines to see how they lay across the data. (Up-to-date versions of Microsoft Excel work the best for these spreadsheets.)

Remember that since the stock market as a whole grows exponentially, what may be an average price today becomes a low price - a good buy - a couple of years in the future. When you chart the historical performance of the stock and provide an "envelope" of CAGR lines that it has been bouncing about in, you have a chart that defines what buy low - sell high means in the ongoing march of history, not just a static set of prices for today.

<http://boards.fool.com/Message.asp?mid=20927198> zach's spreadsheet
<http://boards.fool.com/Message.asp?mid=21463640> gebin's spreadsheet
<http://boards.fool.com/Message.asp?mid=21012433> spreadsheet help in general


5. Do I have to draw them all myself, or is there a central repository of some that others have done?
Several people make available “pre-drawn” CAGR curves for various stocks. You only need to go to the websites linked below and look up the stock which interests you. If yours is not there, you could do it yourself or ask for it to be added.

<http://www.filespace.org/cocomurph2/> Cocomurph1's work
<http://boards.fool.com/Message.asp?mid=20667866> zrpurser's work
<http://f2.pg.briefcase.yahoo.com/tildetoo> hildy's work
<http://boards.fool.com/Message.asp?mid=21457989> mklein9's work through a slightly different lens along with an explanation of what is being done


6. Is this just mechanical stock picking?
No. Once a company's price has dropped to meet the criteria of being a possible BMW stock, due diligence on the company must be done. Without doing this, you will not know the difference between a good company in temporary trouble (which is why the stock price is down) compared to a company that is on its way to the junk heap. Don't be fooled into thinking that every company with a low historical price is a good one to invest in.

<http://boards.fool.com/Message.asp?mid=20984919> IcyWolf discusses DD and the BMW Method.
<http://boards.fool.com/Message.asp?mid=20649641> Example of DD on Goodyear Tire (GT)


7. OK, so it's not Mechanical Investing, because some DD is added in. Is this like Day Trading? What ever happened to Long Term Buy & Hold?

The BMW Method is NOT Day Trading! This is a long-term strategy, and could be classed as LTBH. It is not, however, Buy & Hold Forever. The strategy picks out what a good stock price is so the investor can buy low. The strategy further informs the investor when the stock is at fire-sale prices, so the investor can buy more at a lower price. It is possible that a very skilled value investor could do approximately the same, but none of us are channeling Ben Graham.

The unique thing that the BMW Method does next is to indicate a sell price. Value investors do the same, but it is a sell price for today's situation. Day Traders set a sell price, but it is, again, for today's situation. They may sell next week, or next hour. The BMW Method charts a sell price that is continually adjusted for exponential growth with time. In other words, if the stock has grown exponentially with time at the average CAGR we have charted, and it is currently at the low CAGR, and if our DD leads us to believe that it is a great company that will continue to do the same, then expectations are for the stock price to rise back up to the high CAGR we have charted with time. How much time? Who knows? We must be patient. It is easier to be patient when you have the past charted and have reasonable expectations for the future. BMW would probably say that many of his buys have returned to the high CAGR in one to four years.


8. Isn't this just a variation of reversion to the mean?
Possibly. Recent research into the BMW method has led to another way of looking at it. This involves fitting the data with an average CAGR line, then plotting lines for one and two standard deviations off of that average (within which 95% of the prices should fall). When a stock price is at or outside the minus 2 standard deviations, buy. When it reaches the average (or even goes above it), sell.

<http://boards.fool.com/Message.asp?mid=21457989> mklein9's look at this with various stocks and the DJIA


9. Is there a portfolio that uses this method so I can judge the results?
Yes. As a group, we decide which stocks to buy and at what prices. If they execute, we might buy more at a lower price. The last entry in this thread should have the most currently posted portfolio results.

<http://boards.fool.com/Message.asp?mid=20976573> Port results and comparison to index funds


10. What about taxes?
Pay them as you go after each run up is probably the best way to lock in your gains without having to pay a huge chunk 10, 20, 30 or more years down the road.

<http://boards.fool.com/Message.asp?mid=20929840> BuildMWell on cashing out when it has run up.
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