The BMW Method Conference Call Feb 3, 2007
Acknowledgements:
I have to acknowledge a lot of fine work, taking place it the background, that went into wrapping up first BMW Method conference call. Yoram Carmi (StuyvesantGrad70) worked many hours on editing this post and creating the transcript. Also, Greg Pauba (ReadMNReap) offered the conference call line that accommodates 125 participants and captured the digital voice recording. This is a real effort of volunteers to move the practice of the BMW Method forward. Thank you all.Introduction:
The BMW Method, developed by BuildMWell (BMW, a.k.a. Jim Schout), charts the stock prices of large, established, blue chip companies. When the stock price goes below its 30 year historical compound annual growth rate (CAGR), it may turn out to be an excellent buy, subject to further due diligence.Presentation Overview:
The first BMW Productions telephone conference call featured Jim explaining how he developed and interpreted 3 of his charts. Jim discussed his method with some of the 61 people attending the 2 hour conference. Jim covered the S&P 500 index, Abbott labs (ABT), and Wal-Mart (WMT). Jim's hand drawn charts are available at:Download S&P 500 chart | View chart in new window
Download ABT chart | View chart in new window
Download WMT chart | View chart in new window
Part I-S&P 500
Slicing and Dicing the Chart:
Jim explained his "slice and dice" of the S&P 500 index chart. He drew vertical lines on his chart, starting in 2004 (the year he started working on his chart), and going back in 10 year intervals: 1/2/94, 1/5/84, and 1/5/74. He wrote down the price of the S&P 500 on those dates, and calculated the CAGR for those periods. For the 10-year period, '74-84, the S&P 500 only grew at 5.5%. From '84-'94 the CAGR was 10.7% and then, for the most recent 10- year period, the CAGR is 9%. Jim then calculated the CAGR for the 20 year period '84-'04, and the CAGR was 9.9%. For the 20 years '74-'94, the CAGR was 8.1%. Of course it was pulled down by the low 5.5% and it was pulled up by the 10.7%. Over the whole 30-year period, the average CAGR is 8.4%.
Drawing the CAGR Curves:
Since 8.4% is the average CAGR for 30 years, Jim assumed that 8% would be the long term low growth rate. He drew an 8% CAGR curve, starting with the $98.90 price on 1/5/74. This curve pulls in most of the low points on the historical curve, giving us a bottom for the S&P 500. Jim then drew a 9% CAGR curve. The S&P 500 exceeded that curve only during the stock market "bubble" from 1997 through 2002. Jim throws this data out. He usually discounts the data from 1997 to 2002 because most stock prices were too high and had to suffer the same consequence as the index for being overpriced.
Evaluating the S&P 500's CAGR Curves and Projecting Future Prices:
The S&P 500 has grown between 8% and 10% since 1974, but it has been growing 15% from 2003 to the present, as shown by Jim's green 15% curve. Some people are now saying that the S&P is overvalued, but Jim explained that at 8.5%, it is right in the middle of the two historical compound annual growth lines, and it is neither overvalued nor undervalued. The BMW method looks at the past, and projects where the 20 to 30 year growth rate will take us in the future. The S&P 500 grew at a 10.7% rate for ten years, between January '84 and January '94. So we know that we can have consistent, sustainable 10% growth rates for a ten-year period. Can it continue growing at the 15% rate that it has followed since 2003? Jim said we don't know, but we have to perform due diligence, and look at the external events influencing the economy and the stock market, especially interest rates.
Performing Due Diligence:
Jim asked, what would a rational person do with their money, based on the choices that they have, at any point in time? One reason we had only 5.5% growth between 1/5/74 and 1/5/84, was because the 10 year Treasury Note climbed to over 15% (by 1981). A person had a choice between buying a government Treasury Note paying a guaranteed 15%, or buying a stock that was paying a dividend of say 4%, and maybe not growing at all, because all the money was going into Treasury Notes. Today, the Treasury Note is at 4.6% or 4.8%. Jim explained that the smart money is not going to Treasury Notes now because you can get a 2% dividend, on your average S&P 500 stock, and 8% growth. So the S&P 500 may not be overvalued right now, and it could very well continue going up, but it can only continue to go up at a 15% rate, for a short time, because it just doesn't go up consistently over long periods of time, at that kind of a rate.
Part II-Abbott Laboratories (ABT)
Jim drew the Abbott Labs chart and sliced and diced it, just like the S&P 500. In this case, he used 5-year periods. The first section shows a CAGR of 20.2%, and then 26%, and then minus 1%. Jim drew 13% and 15% CAGR curves. ABT stock was caught up in the same bubble that we saw in the S&P 500. Jim throws out most of the data from 1997 through about 2003, because it is irrational.
The stock collapsed down to around $30 a share, in 2002 or 2003, touched the 13% curve, and then it took off. Then it came back down and hit the curve again, and took off again. It continued to bounce off of the 13% curve, until around December '04. This was a buy point. Since then, it went up to about $53 a share, and just recently it pulled back a little bit. It's going to break out again. If you look at the first peak back in 2000, there was another one actually in 2001, before the collapse took place. We had another peak about a year and a half or two years ago, at around $52. If you take those high points, and connect them together, you find a minus 2% growth curve. So the stock goes up, comes down, goes up, it makes these highs, before it collapses again. What we see is that the weakness in the stock is overcoming the strength of the earnings.
The 13% growth line is basically the rolling earnings per share, this should be put this on the chart, because if you analyze the earnings per share, over time, even though we have some movement above and beyond the average, that line shows a very distinct 14% compound growth rate. Now, if the earnings can grow at 14% as consistently as Abbott has grown its earnings, why should the stock be priced at a compound annual growth rate of 13%? That makes no sense. So when it dropped down to the low, of $38 to $39 in 2005, it was a buy. Because the 13% curve is the low growth rate, the logic is that the price had to go up because the stock was being beaten down unfairly by Mr. Market. The driving force for the price is earnings.
The chart shows a break above the green minus 2% curve. Abbott, in the next two years, is going to start testing the 15% CAGR curve, possibly. Their earnings are going to surprise on the high side. Abbott's PE ratio, was down to around 15 a year ago. Abbott has never sold at a multiple of 15 except once or twice, in the last 25 or 30 years. When you see it at that kind of a low multiple, that just becomes one more little piece of information, showing that the stock is way too cheap. The earnings growth is 14%, and the PE is 15. Something is wrong, because a rational investor should be willing to pay more than a PE of 15 for a stock that's growing at 14%.
Great companies will give you great compound returns, if you just buy them at the right price. The stock went from $39 a share last year to $53 a share, that's a 35.9% compound growth rate, plus at the point in time, it was paying an all time high dividend of 3%. If you notice, it's still under-priced, according to the 13% low growth rate. Now we cannot explain to you why the market offers us deals like this, but it happens all of the time.
Part III-Wal-Mart (WMT)
Jim explained that the Wal-Mart chart today is similar to the Abbott chart of a year ago. Between 1997 and 2002, there are two vertical lines. One is $11.75 per share in 1997, and the other one is $55.76 a share in 2002, and the CAGR between those two numbers is 70%. That 70% is the compound annual growth rate for people who owned Wal-Mart along that curve, and there is another curve, it's not easy to see, at 45%. So the low growth rate from 1997 to about 2000 was 45% per year, and as high was 70% per year. So the people who owned Wal-Mart, during that three-year period, should have been very happy.
But if we look at the PE ratio graph, the PE ratio was 70. So when Wal-Mart peaked, around 2000, it had a PE ratio of 70 to 1. The growth rate was 70%, that's why people justified paying a 70 PE for the stock, but that was not rational, and that is not what we're going to expect long term. No company can grow at 70% per year for very long. Sure enough, Wal-Mart stopped growing when it hit around $70 a share. We had a triple 70: a 70 PE, a $70 price, and a short term 70% compound growth rate. That's why Wal-Mart collapsed. It was irrationally priced, for three reasons. Number one, it was a great company and it was growing. Number two, it was caught up in the bubble, which was driving the price even higher. Number three, the average investor was caught up chasing growth, and, if you could make your money in Wal-Mart, instead of Cisco Systems or Microsoft, that seemed to be a better place to put your money.
Everything was pointing toward catastrophe. From that high price in 2000, the stock has declined ever since. The green shaded area shows two curves of declining compound growth rates. The minus 4 percent curve capture most of the higher highs, and the minus 6 percent curve captures most of the lower lows. Now the price is moving downward toward a rational growth rate. Looking at the middle chart, the rolling earnings per share, have been increasing at 13.68% for 7 or 8 years.
The red highlighted area shows that the low CAGR curve is 13%, the next curve is 14%, and the high curve is 15%. Wal-Mart has hit the low curve, it has bounced off of that curve, not that it can't go lower, but it can't go much lower, than it is right now.
Wal-Mart's PE ratio has declined at a compound annual rate of minus 24%. That is a decline. So what we've got now, is a collision coming, or has already occurred, between a minus 24% declining price growth rate and an underlying earnings growth that is between 13% and 14%. That tells us Wal-Mart is too cheap now, just like Abbott was too cheap a year ago. So, it's a good time to own Wal-Mart.
Audio file and Transcript:
An audio file of the conference call, as well as a written transcript will be available. RGAnthony will have further information on the BMW Method message board.
Future events:
The next BMW Productions telephone conference call will feature IcyWolf (Stan Racis) covering due diligence, and will take place in June or July. For more information about the calls see:
http://bmwmethod.com/conference-calls/index.php
An annual BMW Method conference is planned for Raleigh, NC at the end of September 2007. For more details on the conference, see:
http://bmwmethod.com/conference/notice-2007.php
For further information, about the BMW Method, see the message board FAQs at:
http://boards.fool.com/Message.asp?mid=23878864