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Author: BuildMWell Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 46837  
Subject: Re: The BMW Method Date: 2/7/2004 12:19 PM
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"It is interesting to me how -it seems- apparent declines in growth in earnings translates into substantial stock price drop- as if those who were observing the decline in earnings actually believed the earnings were really falling off. For example, JCOM is now going to pay taxes on its earnings. The threat of this caused the stock to decline a lot. Yet clearly this is not an actual decline in growth in earnings- that is to say- it is not indicative of its future growth curve at all. Yet investors seem to be saying- gee- I see a lapse in the apparent growth in earnings, so I am bailing." - yttire

Actually, that is precisely what I have observed with many stocks. I am not familiar with JCOM but I just did some quick charting and it is impressive...like 70% growth ($1.00/share in 2001 to $20/share today) with a severe peak back last year. To me, the pullback is just normal activity and further pullbacks will also occur because anyone should be scared by 70% growth. However, that in no way makes JCOM any less desirable as a great investment long-term.

This actually raises another good aspect of the BMW method. I see JCOM much like I did CSCO back in 1993 and 1994. There is no 30 year trend. In 1993 CSCO had about two years of data but it was growing at about 70% just like JCOM is right now.

Here is what I learned as time passed on Cisco Systems. The compound growth rate steadily declined each year. Based upon my similar evaluations of "new" tech businesses in the past, I theorized for my charting that Cisco would do like others in the past had done...that is to grow at a declining CGR and approach a more reasonable 25%, 30% to 35% rate. Thus, I actually plotted these "super low" growth rates onto my CSCO curves. No company can grow at 70% for very long...it is mathematically impossible.

Starting in 1993, here are the compound growth rates for Cisco Systems. 75%, 76%, 65%, 64%, 74%, 63%, 68%, 68%, 78%, 78%, 48%, 41%, and 38% by 2004. However, those high rates in 1997 through 2001 were the internet bubble! That was unrealistic as we all now know. Thus the crash.

However, by shifting the staring point for doing the compound growth calculations, the percentages looked much different. For example, Starting in 1995 they were: 30%, 36%, 62%, 48%, 58%, 65%, 40$, 30%, and 30%. I am not sure that I am explaining this well enough, but I was seeing that Cisco was fast approaching a 30% growth rate. I would need to show you all of the data, but that 30% growth rate was embedded into my mind by the charting over time.

So, when CSCO stock recently jumped from $23/share to $29/share, I sold it! As far as I am concerned, Cisco is undervalued at $18/share but severely overvalued at $29/share. Sure enough, it almost immediately started down and is now about $24. I am still not a buyer. When I get back into Cisco, it will be at a reasonable growth rate. If it drops below the 30% compound growth curve, I will get interested. It would have to get to $18/share to get to the 25% growth curve. I actually do not expect that great of a deal on Cisco, but I will be hoping for it. I will place buy orders for that level and see what happens.

In late 2002, CSCO was a steal at $11/share. (It was just below my 25% return curve) But, the experts were saying to "SELL!" However, at $29/share its price is poking above the 35% curve. I could be wrong but I just do not think Cisco will grow at 35% long-term. I watched the stock steadily track on my 30% curve until November 2003. Suddenly, it spiked upward on some good news and I was a seller! To me, buying at $11/share in November 2002 and selling in January 2004 at $29/share was a no brainer. My charts told me so. By the way, Cisco will be a good deal at $25/share by this time next year. But, if that is true, why pay $24/share today? It pays no dividend, what's in it for us if we buy today? At $20/share today we can make 25% on our investment...at $18/share the return is 39%.

Will Cisco drop to under $20/share in the next month? I have no idea. However, unless it does, I will not own but 100 shares. Why own it unless it is going to make a nice profit? If it gets below $20, I will own some more and the truck will be backing up at $18. The bottomline is that I know what I will be doing and exactly why. I am not saying that I know what is going to happen because I do not! However, I know what I am doing even if it is wrong.

If it turns out that I am wrong and Cisco goes to $16/share, I know that it won't be long before Cisco again does what it has done since it started...It will go up in price again. Patience is the key. The only problem I have run into is that I often "back up the truck" on a stock too early...it goes even lower after I buy. If I can work it out, I will buy even more at the lower price knowing that history is on my side. So far, history has not let me down.

Anyway, I hope this explains how the picture can easily change with a new company. That is why I prefer businesses with at least 25 years of performance. They are past that high growth/high return stage. I prefer to make my 70%/year gains on a stodgy old business that is severely undervalued. I find that to be the case over and over again. The market has little faith in history...they tell us so every day. "Past performance is no guarantee of future results."

I laugh every time I hear that! What a pile of crap those words are. Of course there are no guarantees in the future...but the past is all we have to evaluate! That is what the BMW method does. It quantifies the past for me. Then, the future seems very clear to me.

I hope this explanation helps.
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