Profitability Forecasting

 We collectively owe all Value Line analysts an apology. We’ll use this household products leader — and walking, talking and breathing Up, Straight & Parallel business analysis — to take a closer look at profitability forecasting.

Church & Dwight (CHD)

Church & Dwight Co., Inc. engages in the development, manufacture, and market of household, personal care and specialty products. It sells consumer products under a variety of brands through a broad distribution platform that includes supermarkets, mass merchandisers, wholesale clubs, drugstores, convenience stores, dollar, pet and other specialty stores and websites all of which sell the products to consumers. The firm focuses its marketing efforts on its brands, which includes ARM & HAMMER, TROJAN Condoms, XTRA laundry detergent, OXICLEAN pre-wash laundry additive, NAIR depilatories, FIRST RESPONSE home pregnancy and ovulation test kits, ORAJEL oral analgesics and SPINBRUSH battery-operated toothbrushes. It operates through the following segments: Consumer Domestic, Consumer International and Specialty Products. The Consumer Domestic segment includes the eight power brands and other household and personal care products such as SCRUB FREE, KABOOM and ORANGE GLO cleaning products, ANSWER home pregnancy and ovulation test kits, ARRID antiperspirant, CLOSE-UP and AIM toothpastes. The Consumer International segment primarily sells a variety of personal care products, some of which use the same brands as its domestic product lines in international markets. The Specialty Products segment produces sodium bicarbonate, which it sells together with other specialty inorganic chemicals for a variety of industrial, institutional, medical and food applications in U.S. The company was founded by Dwight John and Austin Church in 1846 and is headquartered in Ewing, NJ. [Source: Wall Street Journal]

 

I think we might owe the Value Line analysts an apology.

This might be one of those moments when we realize that something we’ve believed, shared and taught just doesn’t work out the way we expected.

I hate when moments like these happen.

The culprit is usually a Value Line company report. You know the ones I’m talking about. The companies that have been running close to a 5.0% net margin for the last few years and the Value Line analyst has a 3-5 year forecast of 7.5% for the projected net margin. We snicker. Some of us guffaw. Almost all of us discount the forecast.

It’s probably time for a deep breath. A few more moments with curved shower rod curtains while we tack the ends of the ham and restore it to Grandma’s oven. (See Cutting Off The Ends for more on this subject)

The Management Report Card: Profitability

The second part of an SSG-based stock analysis includes a look at profitability trends.

Faced with slide rules and abacus beads, George Nicholson resorted to a moving average for “instant trend analysis.” It’s very straightforward. A comparison of current conditions (higher or lower) versus the trailing 5-year average tells us whether recent results are above (good) or below (bad?) the longer term trend. There is nothing wrong with this convention.

But we use the Preferred Procedure — a business model analysis — to build the long term return forecast for the companies we study and analyze. And we’ve generally used the trailing 5-year average net margin as the projected profitability.

(1) This will build in some conservatism, and (2) we lean on the “excuse” that we’re doing the analysis for each and every company the same — so it’s all “relative.” This too is a decent, but flawed, convention. Even if it’s WRONG.

The problem is that we’re striving for better absolute forecasts.

“The moving average forecast is based on the assumption of a constant model.” — University of Texas, Statistics

 

Does anything about that accompanying chart of long-term aggregate net margin (1940-Present) look CONSTANT???

Church & Dwight (CHD): Profitability Trends. The actual and forecast net margins for CHD are shown in the profitability graphic on the left. The graphic on the right supports a comparison of actuals (red bars, 2009-2016) versus the forecasts (purple bars) based on 5-year trailing averages back at the time the forecasts were formed.

The fact that we have embedded analyst estimates for profitability for this year, next year and 3-5 years out (when available) for our long-term forecasts means that we are less impacted by this condition than what is depicted on the right.

Bottom Line

I think it’s clear that we’d want a forecast for CHD that is essentially between the VL 3-5 year forecast and the exponential regression shown on the left image. It’s probably also clear that for a profitability profile like the one on the left, the trailing average forecast is going to consistently produce a lagging forecast.

Remember the example of margin expansion by Coca-Cola over the years cited by Steve Sanborn. It’s simply a reality that profitability characteristics shape and evolve over the life cycle of all companies.

The moving average forecast method really only works (accurately) for mature stocks with relatively constant profit margins.

The problem is that there aren’t very many companies that fit this description. Our database includes a forecast algorithm that essentially smoothes and weights the more recent years. When we use this method for Church & Dwight, our 5 year net margin forecast aligns very closely with Value Line’s 3-5 year construct. We checked about (50) more companies — and those forecasts that we snickered and guffawed about — all checked out very closely.

We may owe the Value Line analysts an apology.

We will begin infusing this method with updates going forward until the entire database (at Manifest Investing) is converted.

Huge Expectations (An Update)

Value Line 1700 (x-Financials)

We’ll monitor this as we roll along the data array updates over the next several weeks of update batches. But the early returns do show quite a bump in expectations for 2018 and 2021. Here’s an update through 4/28/2017.

Observations

  • This is a work-in-progress. Think of it like “exit polling” with 85% of “precincts” reporting as we’ve logged the forecasts for 2018 and 2021 for issues 1-11 so far.
  • The sales bump for 2018 seems a little less significant, but still material. It will be interesting to see if it persists and if the 2021 expectations remain elevated above the long-term trend.

Just Like Home …

This Expected Returns cover story from April 2009 underscores the things that really matter during bear markets, corrections and recessions.  We were reminded at the time to focus on high-quality opportunities with vigilance for upstart, promising companies ratcheted up.  If you’re curious about our work at Manifest Investing and the resources we provide for long-term investors, and interested in a FREE 90-day test drive, let me know via markr@manifestinvesting.com … for now, may your investing brackets be “nothing but net.”

The stock market madness of early March has given way to a rally that at least delivers welcome respite from the cascading decline we’ve experienced for several months.

Triple Play: A Measure of Opportunity. History suggests that the discovery of companies poised with Triple Play characteristics can lead to rewards. We’ve leaned on Nicholson’s Triple Play concept often since the 4th quarter of 2008, citing potential impact on our shopping efforts. Finding companies with the prospects of potential profit margin and P/E expansion seems prudent. Combining that potential with high-quality companies exhibiting out-sized PARs could deliver a measure of success and shining moments for our portfolios going forward.

 

March Madness now extends into April as the NCAA basketball championships bring the current season to a close. And the stock market madness of early March has given way to a rally that at least delivers welcome respite from the cascading decline we’ve experienced for several months. In the movie ‘Hoosiers’, there’s a classic scene where Gene Hackman, coach of the underdogs from a very small town, leads the boys into the championship venue for their pregame practice. He hands a tape measure to the anxious players and urges them to confirm that the hoop is 10 feet above the floor … just like home … and the free throw line, 15 feet … just like home.

From “Just Like Home” …

As many of you know, we’ve discovered that NAIC/BI co-founder, the late George Nicholson, focused his attention on “the next bull market” during the dreadful bear market of 1973-74. As we studied his writings at the time, we learned that he looked back to the lessons of the 1937-38 bear market — days when he was launching a successful career and lifetime of successful investing.

He believed that the challenges and opportunities of 1973-74 were similar to conditions last seen in 1937-38 complete with year-over-year 50% declines in automobile sales (sound familiar?) and a variety of economic ailments related to scarcity of commodities and mischievous behavior in the banking and investing sectors, etc. He developed a set of criteria — intended to seek opportunities just like “home.”

Although we can’t be certain, I can imagine that he saw it as a sort of antidote to the poisonous paralysis that afflicts so many of us as stock prices decline. In fact, Nicholson “pleaded” with investment clubs to commit to decisions during early 1975 — citing a recent 80% gain in Coca-Cola over a span of less than six months as evidence that prices could and often do, move in sudden spurts. (The stock price of Coca-Cola proceeded to languish for the next 5-6 years.) If you missed the autumn 1974 opportunity to own the Real Thing and waited a few months before committing, your experience was considerably less rewarding.

… to “Shining Moments”

CBS Sports features the song ‘One Shining Moment’ to encapsulate the highlight reel celebrating the coronation of this year’s champion.

Nicholson shared that some of the best shining moments of a lifetime of successful investing could be traced to the elements of his Triple Play concept. Here are the three features that qualify a stock for Triple Play status: (1) A depressed stock price. Think elevated projected returns. (2) A potential for P/E expansion over a 5-year time horizon and (3) A potential for profit margin expansion. Such stocks are most frequently found at the end of a long bear market.

“I have been investing in Triple Play situations during 1973-74 in preparation for the next bull market. If past performance is any guide, the performance should exceed [stock market returns] by a wide margin.” — George Nicholson.

Triple Play Candidates. This listing of study candidates was shared with the attendees at the Better Investing regional conference in Lansing, Michigan on April 3-4, 2009. Our database was screened for companies with PAR>21%; Quality>60; EPS Stability > 60; and Financial Strength > 70. A large number of companies are poised for P/E expansion (not shown) and the screening results shown here are sorted by annualized net profit margin (%) expansion in descending order. Note Solomon Select company, Mettler-Toledo, and the other precision instrument companies.

Bear Down, Regularly

There’s an insurance company commercial running on television where the celebrity sponsor (President Palmer for ‘24’ fans …) shares that we’ve been through twelve recessions over the last 50 years or so. All of them ended and a period of economic expansion ensued.

During a recent seminar, Steve Sanborn, retired director of research for Value Line, and I shared that — in his wealth of investing experience — all bear markets have ended. In that seminar, we explored the history of bear markets and underscored the similarities between 1938, 1974 and 2009 as supported by the accompanying graphic.

The lessons of history suggest that it’s probably time to think less about poisonous paralysis — avoid remaining unduly mired in yesterday’s quagmire — and focus a whole lot more on an effort to engage tomorrow’s prosperity. The table displays a listing of companies with depressed stock prices and the potential for profitability and P/E expansion. Many of these companies were mentioned multiple times by some pretty effective stockpickers and educators at the regional conference in Lansing, Michigan on April 3-4.

The list includes some community favorites, a few newcomers and a few Solomon Select legacy features.

Growth by Recession

It’s probably time for a reminder that our emphasis on focus on size diversification includes a healthy nudge. That nudge entails the continuous pursuit of companies with higher top line growth expectations. It also includes an increased focus or emphasis during periods when we may be approaching the end of a recession.

Bear Market Comparisons. As shown here, the bear markets of 1937-38, 1973-74 and 2007-2009 exhibit some similarities when compared versus all of the bear markets that have come and gone before. No, Virginia, we’re not seeing conditions like the Great Depression (see 1929-32) yet. Nicholson seized the moment in 1973-74, seeking Triple Play candidates to ready his portfolio for the next bull market.

 

You’ll hear some pundits, rhinos and talking heads continuing to encourage blue chip companies and we’ll nod and agree that this pursuit should be continuous, too.

That said, we also heed the advice of Peter Lynch. The Magellan maestro suggested that small companies can be more nimble and recover more quickly coming out of recessions. This reality is one of the things that leads to frustrating periods where blue chip languish while “garbage companies” seem to flourish. An investor over-concentrated in slow-growth blue chips last experienced this during the 2003 bull market.

Dial up shopping efforts and maintain overall portfolio sales growth at the high end of your comfort range. Languish a little less.

I have a small confession. Much like Jim Surowiecki, I’m sometimes conflicted with doubts about how much this “quality stuff” really matters. After writing The Wisdom of Crowds, Surowiecki shares several experiences where he doubted the wisdom of a gaggle of chefs in some “predictive kitchen” only to discover that the collective wisdom held up well … again, despite and in deference to any doubt.

And every time I check, I’m stunned by the reinforcement and rediscovery that comes with it.

2-Year Annualized Returns for Low-Quality Companies. The companies shown represent approximately (20) of the lowest quality ratings as of March 2007. The average annualized loss for this group of companies is 60%. Yes, 60% … and that doesn’t count three companies no longer “on the board” because they’ve gone bankrupt and no longer exist. In a word, Ouch.

The accompanying graphic is from a couple of slides presented at the regional conference — updating a look at bear market performance for low-quality companies versus high-quality companies. Yes, we’re talking about the current bear market.

And yes, the contrast is stunning. And it hits a little close to home as we watch companies like General Motors (GM) drop from $29.27 to $1.94 over a period of two years — an annualized loss of 74% (per year!)

Nicholson’s Legacy Continues

The companies shown in the accompanying graphic are often found on subscriber dashboards and rank among the most commonly-held and widely-followed by our Community. We’re proud, yet humbled, that companies like Solomon Select feature Strayer Education (STRA) tops these charts, compelling us to continue our quest.

2-Year Ann. Returns for Highest-Quality Companies. In sharp contrast, the highest-quality companies combined for an average return of -19% versus a stock market down -27%. Note that three companies (including a couple of community favorites and a Solomon Select alum) managed positive returns!

 

Nicholson strongly cautioned avoiding lower quality companies as bull markets raged. In our vernacular and interpretation, we’d translate that to: “periods where MIPAR is historically low” as our measure of bull market condition.

Where’s your “investing tape measure?” In the spirit of Hoosier coach Norman Dale (Gene Hackman), we continue to urge that seeking Triple Play Candidates and heeding the repeating lessons of Quality are pretty good yardsticks to honor.

Just like home … Indeed.

Huge Expectations

We’ll monitor this as we roll along the data array updates over the next several weeks of update batches. But the early returns do show quite a bump in expectations for 2018 and 2021.

Observations

  • This is a work-in-progress. Think of it like “exit polling” with 30% of “precincts” reporting as we’ve logged the forecasts for 2018 and 2021 for issues 1-4 so far.
  • The sales bump for 2018 is significant and material. It will be interesting to see if it persists.
  • The long term growth trend has been “bent” back to 3.5-4.0% with the optimism. As shown, growth in the “New Normal” has been pretty close to zero.
  • The recessionary conditions for 2015-2016 become a little more obvious here. Although not an official recession, profitability lagged for many companies in recent years. We also see the traditional Value Line analyst optimism in the 3-5 year forecasts for net margin.
  • Average P/E forecasts for 2017 seem a little elevated but not as much as we read and hear from the pundits. If the exuberant forecasts from the rhinos materialize, the burst of EPS (E) will do a lot for the P/E equation. We also note that the 3-5 year P/E forecasts are not “outlandish” and suggest at least a semblance of moderation for the long term outlook, company by company.

Trucking In Tulsa (3/10/2017)

This Week at MANIFEST (3/10/2017)

Common Sense, Care Of Catoosa

“If you want to be successful, it’s just this simple. Know what you are doing. Love what you are doing. And believe in what you are doing.” — Will Rogers

No, I haven’t forgotten that the trucking and logistics stocks are in Issue 2 and that this week’s update centers on Issue 4 — home to many healthcare and aerospace/defense stocks.

It’s just that a significant number of hours sharing lanes with Knight Transportation, Swift, Old Dominion and a number of CVS Health semis provides some time for pondering while en route on Route 66 to the Port of Catoosa. (Tulsa)

Ken Kavula and I were met in Catoosa by a throng of committed long term investors and we greatly enjoyed spending the weekend with them. Ken did his travel research on the Issue 1 airlines and perhaps he can explain Buffett’s sudden interest in the group, but that’s a topic for another day. Probably.

We took a stroll through 70 years of investing better — together. Some rules and guidelines were reinforced. Others were disturbingly challenged. We were reminded how the Tin Cup model portfolio handled the 2007-2008 market challenge and wondered why we spend so much time worrying about asset allocation (shifting to cash equivalents when the market seems overpriced.) Our subscribers fondly remember our 2008 open letter to the Presidential candidates: An Open Letter To The President.

Is the market over priced? What if it’s not? Recall those surging estimates for S&P 500 earnings from the analysts a few weeks ago. If they’re right about 2018, 2019 and beyond …

If the accompanying chart isn’t “haunting” or reinforcing — it probably ought to be.

And in that spirit, we think it probably makes sense to keep doing what we always do … INVEST IN THE BEST, but only when they’re on sale. We’ve never seen a moment where we couldn’t find several worthy stocks. If we ever do, we’ll start worrying about electric fences.

“With a sufficiently long term perspective, bear markets become blips.” — Cy Lynch

Thanks, Catoosa.

MANIFEST 40 Updates

Round Table Stocks

Best Small Companies

(None)

Results, Remarks & References

Companies of Interest: Value Line (3/10/2017)

The average Value Line low total return forecast for the companies in this week’s update batch is 1.9% vs. 2.9% for the Value Line 1700 ($VLE).

Materially Stronger: Community Health (CYH), Regeneron Pharma (REGN), Illinois Tool Works (ITW), Anthem (ANTM), Envision Health (EVHC)

Materially Weaker: Tenet Healthcare (THC), Quality Systems (QSII)

Discontinued: Clarcor (CLC), Tessera Tech (TSRA)

Market Barometers

Value Line Low Total Return (VLLTR) Forecast. The long-term low total return forecast for the 1700 companies featured in the Value Line Investment Survey is 2.9%, down from 3.0% last week. For context, this indicator has ranged from low single digits (when stocks are generally overvalued) to approximately 20% when stocks are in the teeth of bear markets like 2008-2009.

Stocks to Study (3/10/2017)

There continues to be evidence of strengthening fundamentals and 1-year price targets are getting adjusted upward, on balance. Many of the biotech and pharma companies are showing the damage — and resultant higher return forecasts — as a result of “bashing” and criticism from inside the Beltway.

Based on the near term expectations for Round Table selection MEDNAX (MD), it will be interesting to see if we’re truly “early” and/or if we catch a wave as the S&P and Morningstar and Goldman Sachs analysts catch up with us. [Grin] […and Hope]

The Long & Short. (March 10, 2017) Projected Annual Return (PAR): Long term return forecast based on fundamental analysis and five year time horizon. Quality Ranking: Percentile ranking of composite that includes financial strength, earnings stability and relative growth & profitability. VL Low Total Return (VLLTR): Low total return forecast based on 3-5 year price targets via Value Line Investment Survey. Morningstar P/FV: Ratio of current price to fundamentally-based fair value via www.morningstar.com S&P P/FV: Current price-to-fair value ratio via Standard & Poor’s. 1-Year ACE Outlook: Total return forecast based on analyst consensus estimates for 1-year target price combined with current yield. 1-Year S&P Outlook: 1-year total return forecast based on S&P 1-year price target. 1-Yr “GS” Outlook: 1-year total return forecast based on most recent price target issued by Goldman Sachs.

Apple & Long Term Perspective

The business model changed …

Growth appears to be plateauing …

P/E ratios are moderating and settling into “mature company” characteristics for this industry …

Stock price follows earnings.

How many times have you scratched your head over questions like these during your studies of companies? Our most widely-followed company, Apple (AAPL) turns out to be a pretty good study of changing conditions for company over a span of a few decades. Here’s the business model visual analysis.

Apple (AAPL): Business Model Analysis (1984-2020). Did you know that the road to “today’s Apple” and the mother ship piloted by Tim Cook was this bumpy and turbulent? There’s a couple of things that stand out — from the long term double digit growth to the years with negative earnings (1996-1997,2001) to what clearly seems to be a new trajectory over the last decade.

Apple (AAPL): Profitability, Net Margin (1984-2020). The volatile profitability of the company is on full display for 1984-2005. When speaking of shifts in business models, it can often be discerned from the profitability profile and Apple is something of a poster child here. Note the ramp up as the iPhone emerged as a ubiquitous necessity and the elevated net margins delivered over the last several years. This is how a company ends up with $80 billion in the check book after paying dividends and buying back 20-25% of shares outstanding.

Apple (AAPL): P/E Ratios (1984-2020). One of the things many investors have wondered about Apple over the decades is “Why the P/E of 10x or so?” The answer lies in the preceding roller coaster of bottom line (profitability) — a condition that inhibits P/E ratios for most companies. The P/E ratio has actually been pretty stable over the years, considering, and a case for low to mid-teens can be made and substantiated. One could also argue that continuing to maintain the current profitability levels could promulgate some higher P/Es …

Round Table (November 2016)

November Round Table

Our Round Table, a monthly session featuring our favorite stock ideas right now in true round table fashion, was held November 29.

Stocks Discussed

  • CVS Health (CVS)
  • Infosys Tech (INFY)
  • Mercadolibre (MELI)

The stocks selected for this program over the last six years have collectively beaten the Wilshire 5000. The excess return (annualized) has been ranging from 2-3%. We seek actionable opportunities to study and pursue.

The agenda will also include a continuation of our selling decision concept based on relative return.

The round table knights include small company champion and Mid-Michigan Director Ken Kavula; Cy (MythBuster) Lynch; pharmaceutical scientist Hugh McManus; and Manifest Investing’s Mark Robertson who will analyze their favorite stocks. Guest damsels have included Anne Manning, Susan Maciolek and Kim Butcher. Guest knights who have jousted include Nicholas Stratigos, Herb Lemcool and Matt Spielman.

The audience selected CVS Health (CVS).

Positions closed/sold: Knight Transportation (KNX), Landauer (LDR), PRA Group (PRAA), US Physical Therapy (USPH)

The tracking portfolio has been updated at: https://www.manifestinvesting.com/dashboards/public/round-table

Rt poll 20161129