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Author: realzen Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 265  
Subject: Percentages not points Date: 5/23/2000 11:49 AM
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Percentages not points vs Rising Gross and Net Margins

First let me say that I thoroughly enjoyed the Rule Breakers, Rule Makers book and intend to use the model. Second, a disclaimer stating that whilst I regularly read the website, I am not a regular to this board so the things I mention may already have been covered.

I have been reading this book with a critical mind, analyzing the motives of the authors as much as they exhort us to analyze the motives of brokers and the "wise". So far I believe that whilst what motivates brokers and what motivates investors are at odds with each other, what is best for this web site and the Fool culture is the same as what is best for investors in general. However I will maintain a continuing analysis to ensure this doesn't change.

Now on to two points about this book. First is a minor point. Has anybody picked up the typo on page 242-243? Disney's net margins are 9% and under the model given, that earns 1 point not two. Minor but something which can be changed for the next edition in the pursuit of excellence.

Secondly, the discrepancy between Chapter 7 entitled "Percentages not points" and page 264 "Six metrics of business momentum". Under the criterion for Rising Gross Margins and Rising Net Margins, the model uses 3 points for growth, 2 for falling 0-0-1%, 1 for falling 1-3%, and 0 for falling greater than 3%.

The problem is when you compare percentage points to percentage points, it becomes a point not a percentage. Huh??? Scratching your head in confusion?

Lets do an example. Business AAA has net margins of 15% in 1997 and 12% in 1998. This drop of 3 percentage points gives it a score of 1 point. Compare Business XXX which has net margins of 4% and drops to 1%. This drop of 3 percentage points also gives it a score of 1 point.

But AAA has dropped it net margins by (15-12)/15 = 20% whereas XXX has dropped its net margins by (4-1)/4 = 75%.

Understandably the two parts of the book were written by different people. Also, using points instead of percentages is a simpler method, misleading but simpler (as mentioned in Chapter 7). Additionally, the Financial Location point system does balance out the Financial Direction slightly (because the Location point takes into account the size of the net and gross margins).

However in the spirit of never pointing out a problem if you have no solution to offer, I offer the following.

Strictly following the book, under Chapter 12, "A measure of excellence" page 221 gross margins above 60% 2 points, 40-60% 1 points, below 40% 0 points. Therefore, take the mid point as 50% gross margin.

A 1% gross margin drop to 49% actually equals a 2 percentage point drop in gross margins. A 3% gross margin drop to 47% equals a 6 percentage point drop.

So altering page 264 (Rising Gross Margins) slightly, I suggest if gross margins grow it should earn 3 points. If fallen by less than 2 percentage points then it should earn 2 points. If fallen between 2-6 percentage points it should earn 1 point and falling greater than 6 percentage points it shouldn't earn a point.

Following the same method for Net Margins page 223, we find the mid point to be 8.5% net margins.

A 1% net margin drop to 7.5% actually equals a 12 percentage point drop (rounded to nearest full percentage point). A 3% net margin drop to 4.5% equals a 35 percentage point drop.

Therefore net margins grow = 3 points. Net margins fall by less than 12 percentage points = 2 points. Net margins fall between 12 and 35 percentage points = 1 point. Falling by greater than 35 percentage points = 0 points.

It may be that the net margin percentage point drops are too excessive but that's subjective so lets not get into that. In this, I've used the book as much as possible, only pointing out the discrepancy on Chapter 7 "Percentages not points" with the Rising Gross and Net Margins. I've tried to avoid any personal opinions.

This level of complexity may be at odds with the model being simple to use. I just offer this up as a criticism and solution so that everybody keeps their minds lively and continues to question that which is given to them instead of blind acceptance.

With humility and a lopsided smile,

realzen
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Author: TMFDryad One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 229 of 265
Subject: Re: Percentages not points Date: 5/23/2000 3:55 PM
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Realzen,

Thanks for your magnificent post!

On your first and most simple point, I hasten to reassure you that the typo on pp 242-43 has been corrected for subsequent printings. Our publishers are optimistic about our sales and so print in large quantities which often leads to typos persisting longer than we would like.

On your second point, I would like to thank your for your thorough analysis and for your constructive solution.

We are in the middle of revising and updating our first two books: You Have More Than You Think and The Motley Fool Investment Guide. After we complete the edits to those, we plan to move on to the Workbook and Rule Breakers, Rule Makers. Your insights offered here about the point system will be incorporated into our editorial discussions about what to improve and how to improve it.

Three cheers for rigorous analysis and fully engaged minds!

Foolishly,

Gabrielle
External Publishing Fool


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Author: realzen Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 232 of 265
Subject: Re: Percentages not points Date: 5/30/2000 2:19 AM
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A man appears out of the black hole of cyberspace and walks onto the stage.

“Hello!” He pauses to smile then says, “Some while ago, I began to say: Humans are all fools. To introduce some humility I then started to say: Fools us all and none greater than I. Then with more humility came: Fools us all and none more average than I. Now I'm just saying: Fools us all.”

He shakes his head and chuckles to himself.

“Well enough foolish trivia. Here is the meat of it.”

The man pulls out a small book from his satchel and with a flourish of his hand opens the cover. A stream of words pour out of the book and into the cyberspace.

He winks, clicks his heels twice and vanishes!
___________________________________
Dear Gabrielle,

Thank you so much for the wonderful welcome and the post recommendation!

I must admit that when I sent that post I had still not read the last couple of pages. So in an effort to help out with the typos:

Problem: Page 291 and Page 292 have the same thing about comparing percentages to percentages becoming points not percentages as pointed out in the earlier post.

Solution: Can't really offer a solution here because it is probably dependent on the industry. And unlike the previous post, any solution I offer will be more subjective as opposed to objective and based on the books model.

Problem: Page 297 Microsoft has more than 5 times Sun's cash. Also Page 297 there is a discrepancy in the flow ratio in the text and in the summary list.

Solution: Nuff said.

Problem: Appendix Ranking Rule Makers. Under Pfizer, you mention that the number used in the appendix are from a different period than that used in the text. From what I could see, actually all the other companies in the appendix are using different periods than the text.

Solution: I suggest opening the whole appendix with a little note at the bottom stating numbers used here are different from those in the text.

Okay get ready for the longer one.

Problem: Page 307 “Half of the mutual-fund tragedy is about subpar performance. The other half of the haunting tale is about overly high annual fees.” I believe this might be a bit misleading. However (here comes the disclaimer bit!) I am fairly new to the US market and some of my assumptions may be wrong. To minimize this problem, I will state my assumptions when I'm finished offering the solution.

Solution: I suggest the following albeit more expanded and explained.

“All of the mutual-fund strategy is about subpar performance. The returns from mutual-funds are sub par compared to the index because of three factors. Firstly, the high annual fees. Secondly, the tendency to trade in and out of stocks in search of superior returns gives rise to greater transactions costs. Thirdly, the trading in and out gives rise to tax implications further increasing costs.

In addition, to these three factors, the manager may or may not be good at choosing the right investments.”

Assumptions: Firstly, the mutual fund performance figures reported already include all three factors' costs. Secondly, there are tax implications.

One final suggestion/request. I am very interested in Soapbox.com. Much like it is the Fool.com's mission to demystify investing, it is my mission to demystify philosophy. I believe I have much more to offer as a philosopher as opposed to my limited experience in investment. So as my final suggestion/request, a section entitled “Fun, Folly & Filosofy!” would be in keeping with the theme of the site.

I hope you enjoyed a plate of confident suggestion with a dose of humility to prevent and preserve against the rot of arrogance.

Thank you once again.

realzen


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Author: TMFDryad One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 233 of 265
Subject: Re: Percentages not points Date: 5/30/2000 9:13 AM
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Realzen,

Thanks so much for your further comments. I like your suggestion about opening the appendix with a comment about the time periods used differing from the way they were discussed in the text. And, as with your comments on the points v. percentages dilemma, we'll come back to your suggestions about the mutual fund performance issues when we revise and update.

For Soapbox, I enthusiastically encourage you to apply directly to Soapbox.com to share your insights. You will not, I am sure, be surprised to find a number of Fools who are refugees from academia from a broad range of subjects: English, Comparative Literature (that's me), Classics, and Philosophy to name a few. Given your careful reading, clear thinking, insightful analysis, and humorous writing, I'm sure you'll have much to offer.

Foolishly,

Gabrielle

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