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Investment Analysis Clubs / The BMW Method


Subject:  Re: BMW Assumption #1 Date:  3/11/2018  12:00 PM
Author:  SubGuy Number:  42212 of 42349

The concept of Average CAGR assumes that a stock at some negative RMS will eventually rise back up to the 0 RMS line and higher. The question is how long until this reversion takes place.
How long should we be willing to wait?
Some people use 3 years, some use 5 years.
For low Average CAGR stocks, one would naturally want the reversion to happen relatively soon for a worthwhile CAGR on the investment.
For high CAGR stocks, the investment could easily grow at a satisfactory CAGR even if it takes a long time to reach 0 RMS again - see MO, SBUS, TJX, ROST, etc.
On the other hand, how do we distinguish between high Average CAGR stocks that will continue at a satisfactory growth rate, and busted growth stocks that will never revert?
How long am I willing to wait for the thesis to prove out?
In my bias for DGI stocks, I tried using 1 / Yield as a proxy for duration, but this has kept me out of some really good growers that never quite got to a low enough RMS. It also gave buy signals for value traps like PBI, which clearly will never get back to its long-term 0 RMS line, and busted growers like TEVA, where the dividend was soon cut, then eliminated.

Clearly, 1 / Yield can be a false signal if management holds on too long to a dividend that can't be supported by the underlying business. The market knows this before the BMW Method does.

There are some companies that 'could' pay a healthy dividend, but choose not to - see AAPL before it started a dividend, or BRK now. 1 / Yield doesn't work for these either.

I think Enterprise Value / Free Cash Flow would be a better metric here. It can catch highly profitable slow-growth companies, and fast growers with healthy balance sheets, and helps to avoid value traps.

EV drops with stock price, but responds slowly for highly indebted companies, so that a value trap like TEVA would need to drop much more in price before getting a buy signal. TEVA at $30 was not a good buy; TEVA at $12 was a good buy.

My next challenge - how to better determine a forward-looking FCF value for the EV / FCF ratio.
More on this later.
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