How to Monitor a Stock's Performance

You can very easily monitor the performance of any stock or mutual fund by doing the following:

1. Go to the website: www.bigcharts.com

2. Enter the ticker symbol of your stock or mutual fund in the box titled, "Enter symbol or keyword."

3. Click on the red button at the top of the page labelled, "Interactive Charting."

4. You'll see a new page with your stock's (or mutual fund's) details listed. On the left-hand side, click on the button labelled "Compare to," and select the S&P 500 from the pulldown menu labelled "index."

5. On the left-hand side, under the button labelled "Time Frame," choose six months from the pulldown menu labelled "Time."

6. Once you've selected the "Index" and "Time," click on the red "Draw Chart" button at the top of the left-hand menu. You will get a graph comparing your stock (or mutual fund) to the S&P 500 for the period of time you specified.

7. Then, ask yourself these two simple questions:

First, is my stock (or mutual fund) making me any money?

Second, is my stock (or mutual fund) doing at least as well as the S&P 500?

If the answer to either of these questions is no, then sell it and don't look back!

If the stock (or mutual fund) happens to turn up just after you've sold it, don't let that bother you because based on the information you had at the time you sold, you made the right decision!

* * * * *

How to Read an Annual Report - Part 2

The Financial Statement

The financial statement area usually includes the Income Statement, Balance Sheet, Statement of Cash Flows, Statement of Shareholders' Equity, and Footnotes.

The Income Statement shows the company's performance during the past year and whether or not its operations have resulted in a profit or loss.

The Balance Sheet is a snapshot of the company at the end of the past fiscal year. Assets include all of the company's goods and property and can include receivables and prepaid expenses. Liabilities include all debts and unpaid expenses as well as future payments and deferred income.

Shareholder Equity is the shareowners' interest in the company; it is the difference between what the company owns and what it owes.

The Cash Flow Statement should allow you to see if adequate amounts of cash are being generated. You should also be able to understand from where the cash is coming and how it is being handled. The Shareholders Equity Statement should give greater clarity to changes in the equity section of the Balance Sheet. Changes here often can be traced to corporate profits or losses, changes in dividend payments, and the issuance or repurchase of company stock.

At the end of these statements come the footnotes. You should take the time to read them because they can provide some important details and explanations to various items mentioned in the previous reports. They should help to explain why certain things have been done the way they have and increase, not decrease, your comfort level. Pay special attention to any notes relating to income and expenses. Information on expensing employee or executive stock options may be found here, and you can look at the possible impact this may have on future financial results.

Usually, the financial section of an annual report will end with the Auditor's Report. This is an opinion letter from the accounting firm that has reviewed the company, typically stating that the company has used generally accepted accounting standards in compiling and reporting its financial results. Remember, however, that it is not an endorsement or a statement that the company's stock is currently a good buy. Check to see if the opinions are "qualified" or "unqualified." If any parts of the opinions are qualified, check them carefully to understand what is being questioned and the possible impact it may have. Also, look for "exceptions" to "standard procedures" and determine whether they represent any significant issues. For example, significant profits may have been generated from the sale of a business or other asset, and you should be aware that this is a one-time event.

If you are not familiar with accounting terminology or methods, questions on the points noted above provide a good opportunity for you to call the company's investor relations department. They should be able to tell you in plain English the meaning of any significant auditor notes or comments. If you receive an answer you don't understand or that makes you uncomfortable, either keep questioning or else move on and consider a different stock to purchase.

The management, and other items of corporate information provided in an annual report are worth studying. What is the age of the management team and how long has it been together? What happens at retirement if they are all the same age? Do you consider it a positive or a negative that every officer and half of the directors have the same last name? Does the board represent enough variety in both talent and experience to move the company forward?

Directors often are compensated, and you should make sure that the company's policies on compensation are stated, clear and reasonable. Compare them to other companies of the same size and structure. How much company stock do the directors own, and are they buying or selling? Do you want them to have a significant stake in the company in which you are planning to invest? Are they costing the company too much in relation to its size and the value that they can provide?

Finally, a good annual report will make it easy for you to contact the company to discuss any questions or concerns you may have. The report will list phone numbers, e-mail addresses or website addresses for the company's investor relations or shareholder relations department. Most companies have a website that may contain a wealth of additional information to make it easier to communicate. Many such sites also contain prior years' annual reports for you to read and compare.

The bottom line is that annual reports can be a valuable resource for fundamental information about publicly traded companies. While investors need to gain skill in looking beyond the sleek marketing spin that can be evident in some of the company's written outlook, important details can be found regarding the potential for future growth opportunities. However, one must be willing to spend the time reading, thinking, and analyzing. Investors will need to take the time to learn how to read and decipher annual reports in order to understand what they are looking for, and these two sections (Parts 1 & 2) can serve as a good starting point for you!

A great deal of important information is sitting within quarterly and annual reports, but investors need to know how to actually mine this information. The more an individual knows about a particular company, the more likely the decision to invest in that company will be a sound one!

* * * * *

How to Read an Annual Report - Part 1

An investor should always study a company's annual and quarterly reports with a critical eye. The financial statements found there are the basis for fundamental analysis because a company's current and past performance are seen as the primary factor in a stock's value. And the discussion sections will give you valuable insight into management's thinking and, hopefully, the quality of their leadership.

Most annual reports will contain the same basic elements, sometimes with different titles and emphasis.Understand the purpose of each and know how it should impact your overall decision to buy, hold, or sell the company's stock. The report contains a letter to shareholders, usually from the chairman, president or CEO, and clearly is directed to you, the investor. The letter will talk about the company's performance over the past year in relation to the plans and goals set out in the previous report. If the year's performance has differed significantly from what was forecast a year ago, explanations will be provided. A plan for the upcoming year or more is set out and probably includes some additional expectations and goals.

Don't just glance through it, but rather, look at the contents of the letter critically. Is the leader or management team clear about the direction they are taking the company? Do they state their goals and how they plan to achieve them? How do the current goals compare to what management has stated in the past? Do they talk about growing the company or only focus on products and services that currently are doing well? Are you aware of any significant issues that management has ignored?

The next element is usually some type of company summary or overview. This explains how the company operates and provides information about products or services and how the company makes money. It probably includes a discussion of current trends affecting the business and lays out the plans for moving the company forward. It may expand on plans and goals mentioned in the shareholder letter.

Again, look at this information with a critical eye. Can you understand how the business works and what makes it profitable? Is management changing the core business or focusing on an area in which they have not worked before? If so, what will this mean to future business? A new product launched into a traditional area should not be cause for alarm. But focusing significant company resources on a new and uncertain area may give one pause.

In both the letter and the overview, traits can emerge that should make you think about the quality of a company's management. Compare those who blame the market, the economy or other outside influences to those who admit failure or own up to not forseeing an unfavorable trend that has had a negative impact. Good management will explain their plans for the future and be open about the possible risks. It also will discuss how they will handle risk and quantify their expectations for growth and profits.

The Management Discussion and Analysis (MD&A) section is a required disclosure mandated by the SEC. This section is the management team's discussion of both the results of operations during the year and plans going forward. The MD&A is a source of good information for fundamental analysis and often is an easier-to-understand summary of key points in the financial statements. Why were revenues up or down? How about gross margins on earnings and earnings per share? What is the current state of the facilities and equipment? Is there discussion of upgrading older equipment or replacing it with new? Is there a mention of new factoies or service centers?

The MD&A also can provide information about significant upcoming changes in the company's condition. Does it look like certain plans will create a significant amount of new debt? Are future stock offerings planned that may raise new capital but dilute the value for current shareholders? If significant capital expenditures are planned, how will they be financed? Information presented in the MD&A can provide clues to management's expectations for the future and how they will achieve them.

Search for comments on competition or other challenges that the company may face in the future, and compare these to comments made about the current year. Look at the history of revenue and earnings growth in the financial statements. If the same management team has been able to grow the company consistently over a five-to-ten-year span, you can feel more confident that they have successfully faced a variety of challenges. When you invest in a company, you are really buying the current management team. Read the MD&A section of the annual report to find out how management is doing.

- Next time: Part 2 - The Financial Statement

* * * * *

The Three "Little" Words of Successful Investing

We all know the three little words at the basis of successful marriages. But do you know the three little words at the basis of successful companies, the type of companies that are sought after by long-term investors?

The three little words I am thinking of are not so little. Also much more pompous. The words I have in mind are "sustainable competitive advantage."

A bit of a mouthful, but vital if you are looking for a company that is going to make excellent profits year after year. Such a company needs a competitive advantage and it needs to be able to maintain this advantage.

Before I get to them, there are another three little words that should be imprinted in the minds of every investor. They are contained in the famous statement by Benjamin Graham, known as the Dean of Wall Street: "Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, margin of safety."

Warren Buffett supported this choice in an annual report of Berkshire Hathaway when he wrote, "Forty-two years after reading that, I still think those are the right three words."

These three words are apt for every form of investment. No matter what we are doing in the world of stocks, without a margin of safety, we are treading close to the quicksand of speculation.

Returning to the words, "sustainable competitive advantage" - a competitive advantage can come from many sources. Products and services; ability of management; sales organization; labor and personnel; brand recognition; and location, to name some of the main ones.

Something more is needed, however, if an advantage is to be maintained and not washed away by the competition. In simple language, it needs a barrier.

This barrier could be geographical. Consider a shopping mall. Most of its visitors will come from the surrounding region. This makes it unlikely that another mall will be built nearby. Also, the shopping mall two towns away is not a competitor because most people will not want to drive that far. At least not on a regular basis.

Peter Lynch talks about rock pits as also having a geographical barrier. The cost of hauling sand, gravel and rocks, means that you have a virtual monopoly for an hour's drive around your pit. Someone else selling in your "neighborhood" would find their profits eroded by these haulage costs.

Another barrier is an economic one arising in industries where the cost of production decreases sharply with quantity. If the market is dominated by one producer, then it is difficult for a competitor to gain a toehold. This is referred to as a natural monopoly. Consider how much it would cost to make a single computer chip to compete with a top-of-the-line chip from Intel. Literally billions of dollars.

Strength of a brand name is another barrier that is difficult for any competitor to breach. "If you gave me $100 billion," declared Warren Buffett, "and said take away the soft drink leadership of Coca Cola in the world, I'd give it back to you and say it can't be done."

Other brands that distinguish the companies from their competitors range from Walt Disney to Harley Davidson.

Intellectual property locked up in patents and copyrights also acts as a protection for a company.

The most powerful and enduring barrier any company can have is the quality and determination of its people, from the top management down through all the levels. There is no simple way for an investor to judge quality in the area of personnel. One place to start however, is to keep an eye on newspaper reports about the company. Signs of unrest and excessive labor turnover, whether voluntary or through large scale dismissals, can be an indicator to pass over the company as an investment.

One marker for companies with a protective barrier is that they have a level of return on capital that is both stable and high. This is because their competitive advantage allows them to have more control over the prices for their services or products. If there are other companies in the same sector, then it is likely they will have a lower return on capital.

Consider Intel versus Advanced Micro Devices (AMD). Intel has a return on capital of approximately 26 percent whereas AMD is struggling to stay in the black. The average return on capital for the semiconductor industry is around 16 percent.

Another company with a lofty return on capital is Gillette. Over 20 percent for the past 10 years. Even though its earnings have recently been under pressure, its ROC is still over this level.

The economist John Kay refers to those aspects of a company that give it a protective barrier as a strategic asset. For long-term value, start with companies that have the sort of strategic assets described above. Within this group of companies, look for those with management that understand the value of these assets and have the determination to develop them to their fullest.

Properly managed, these strategic assets provide a sustainable competitive advantage. They allow a company to get a higher return on capital than their competitors and to maintain this over time. If you pay a reasonable price to buy into a company that has strategic assets as well as a management that understands their value, your investment will keep you happy for many years!

* * * * *

From Kiplinger's December, 2004 Issue

Real Estate Partnerships are back, and they still stink!


Real estate limited partnerships are experiencing a renaissance. Also booming are sales of their close cousins, relatively new financial inventions called private real estate investment trusts. These nontradable vehicles are set up like regular REITs for tax purposes but look much like LPs in other key respects: they come with high fees and are difficult to unload.

You can read further on this subject by turning to pages 58 and 59 in the aforementioned edition of Kiplinger's Personal Finance.


* * * * *

25 Ways to Protect Your Wealth

Keep your wallet lean

1. Keep extra credit cards at home until you need them.

2. Never keep a PIN or password in your wallet. Memorize your Social Security number.

3. Keep personal documents - such as your Social Security card - at home in a safe place.

4. Be vigilant when carrying around important documents. Return them to a safe place as soon as possible.

5. Never leave your purse or wallet unattended. Ever!

Know the hot spots

6. If mail delivery is sporadic or stops altogether, contact the post office to determine if a bogus change of address form was filled out.

7. When travelling, have your mail held at your local post office or picked up by a trusted neighbor.

8. Leave outgoing mail that contains personal information (especially bills with check payments) at the post office, not in your mailbox.

9. Beware of mail or telephone solicitations disguised as promotions offering instant prizes or awards designed solely to obtain your personal information or credit card numbers.

Be vigilant

10. Never give out your Social Security number or account numbers over the phone or by email, unless you have initiated the contact, and have a trusted business relationship with the company.

11. Question suspicious phone calls to you.

12. When asked to give your Social Security number for documentation, ask why it's necessary and insist that an alternate means of identification be used instead!

13. Never throw out credit card receipts in a public trash can. Take them home and shred them.

14. When paying your credit card bills, don't put the entire account number on the check. Just put the last four digits; the credit card company knows the rest.

Tidy up your affairs

15. Buy a shredder and use it.

16. Cancel all unused credit cards and bank accounts. If you're not using them, get rid of them!

17. Don't leave important identification documents laying around the house or at work.

18. When you close a bank account, destroy all leftover checks.

19. Shred or destroy all credit card offers.

20. Shred or destroy courtesy checks sent by your credit card company.

21. Pick up your new checks at the bank. Don't have them mailed to your home.

Plan for the worst

22. Keep a current list - or photocopy - of all credit cards, account numbers and customer service numbers in a safe place, so you can quickly contact creditors and banks in case of theft.

23. Photocopy the front and back of all the cards in your wallet (credit cards, insurance cards, etc.). All of your account numbers, expiration dates and phone numbers will be in one place if your purse or wallet is ever stolen.

24. Read your monthly credit card statements. Keep an eye out for transactions that you didn't make.

25. Obtain your credit report annually... and read it!

* * * * *

Next Meeting on November 18, 2004

Our next meeting date will be on Thursday, November 18, 2004

Our featured speaker will be Mr. David Covas, of Oberweis Securities in Aurora, IL. And Mr. Covas will talk about insights that they have used at Oberweis to ferret out winning small cap and microcap stocks. And there will be time for a question and answer period following his talk.

The meeting begins at 7:00 PM and ends at 9:00 PM. Our meeting location is DePaul University - Naperville Campus. The University is located at 150 West Warrenville Road (at the intersection of Warrenville and Herrick Roads) in Naperville.

The annual membership fee remains at $15.00 per year. There is a $5.00 fee per meeting for visitors as well as any member whose dues are in arrears.

The AAII West Suburban Sub-Group meets on the third Thursday of each and every month throughout the year!

Any comments, questions, or suggestions should be directed to Bob Moser at : rwm123@hotmail.com

* * * * *

Selecting Stocks the Benjamin Graham Way

Benjamin Graham was a genius. When he graduated from Columbia College he was offered teaching positions in English, mathematics and philosophy. But as fate would have it, he started his career on Wall Street working for Newburger, Henderson and Loeb as a runner delivering checks and securities. His talent was soon recognized and within a few months he was writing one of its daily market letters.

His reputation as the father of value investing can be dated from 1928 when he started teaching a course, Advanced Security Analysis at his old college. He had been thinking of writing a book and he reasoned that the best way to get this done was to start by preparing and teaching the material in a classroom setting.

The notes from the course were transcribed by David Dodd and formed the basis of the investment classic, Security Analysis, which was published in 1934.

Graham's classes were often attended by financial analysts who freely acted on the tips given by Graham. In fact, many admitted that his courses were so profitable that they attended them over consecutive years. His classes and the Graham and Dodd book were the foundation of a whole new approach to the investment industry based on principles that appealed to common-sense, but were at the same time exceedingly effective. "Understand the difference between price and value" and "always allow for a margin of safety" are two examples.

One of Graham's early rules was the Net Current Asset Value (NCAV) approach which he defined as the current assets of a company less all of its liabilities. In his later years he defined other combinations of conditions that could be used by any investor to find attractive stocks. And in the 1970s, he described a set of ten criteria that, he declared, "seemed to be practically a foolproof way of getting good results out of common stock investments with a minimum of work."

The ten rules developed by Graham are to choose stocks with:

1. An earnings-to-price yield at least twice the AAA bond yield.
2. A price-earnings ratio less than 40 percent of the highest price-earnings ratio the stock had over the past five years.
3. A dividend yield of at least two-thirds the AAA bond yield.
4. A stock price below two-thirds of tangible book value per share.
5. A stock price two-thirds "net current asset value."
6. Total debt less than book value.
7. Current ratio greater than two.
8. Total debt less than twice "net current asset value."
9. Earnings growth of prior ten years at least 7 percent on an annual basis.
10. Stability of growth of earnings in that no more than two declines of 5 percent or more in the prior 10 years.

The first five criteria were meant to determine "reward" and the second five "risk." And it is interesting to note that Benjamin Graham included "stability of growth of earnings" as one of the criteria!

In 1984, Henry Oppenheimer published a study of Graham's selection criteria in the Financial Analysts Journal. He used various groupings of the criteria to test which were the best at predicting superior performance over the period from 1974 to 1981. Amongst other results, he found that an investor who chose stocks using just criteria (1) and (6) would have achieved a mean annual return of 38 percent compared to a market return of just 14 percent. Use of criteria (3) and (6) would have given an annual return of 26 percent.

Oppenheimer also observed that the performance of Graham's criteria declined after 1976, but still outperformed basic benchmarks.

Just as with any other screening method based on simple criteria, results can be excellent in one period and limited in another. So blind application is never recommended. But as a starting point for finding quality stocks, Graham's ten criteria are well worth a second look!

* * * * *

Forbes Magazine - November 15, 2004 Issue

A couple of articles in this issue are especially interesting!

Beginning on Page 92 - "The Dividend Elite" by John H Cristy - Tells us that while payouts are now back in style, one should not just buy stocks with the highest current yields but instead, we should look for those with the highest future yields.


On Page 208 - James Grant's column entitled, "Where To Find A Good Yield" - he profiles the REIT, Annaly Mortgage Management (NLY) and explains how this mortgage REIT can pay you 11.8% while still avoiding a lot of risky credits.

* * * * *

Is This Evidence of a Shifting Tide?

There has always existed within the investment community a debate between active and passive money management, and the topic is now receiving attention from the broader financial media. A recent front-page article in The Wall Street Journal (October 18, 2004 - "As Two Economists Debate The Markets, The Tide Shifts") provided a summary of the debate, led by Eugene Fama Sr., proponent of the efficient market view, and Richard Thaler, who supports a behaviorist explanation of the workings of capital markets.

The efficient-market hypothesis posits that markets quickly digest information and provide the best estimate of a firm's economic value, so that consistently trying to beat the market is futile. Behaviorists, on the other hand assert that investors' collective behavior is not always rational, so that irrational pricing results, along with possible opportunities for investors to "beat the market."

The behaviorist view has apparently gained ground, but this momentum appears largely to be driven by anecdotal evidence. Behaviorists point to apparent market timing and stock pricing anomalies, such as the run up and subsequent collapse of tech stocks in early 2000, and the price of Palm, Inc., which after its initial offering was almost double the market value of its parent 3 Com, despite the fact that 3 Com held all but 6% of Palm's shares. But to simply accept irrational pricing as an explanation for these events would be a rejection of the notion that investors expect an appropriate level of return for the risk they assume. That in turn would force us to throw out all we think we know about a firm's cost of capital. The job of an economist as a social scientist is to seek explanations of phenomena that are consistent with what we think we know to be true. We should not throw out fundamental tenets about the way markets work simply because we are faced with an apparent inconsistency.

While we find the academic wrangling to be interesting, what we care about most at the end of the day is how to invest wisely. To address that question, we skip to the last paragraph of the article. There Professor Thaler admits that rather than trying to identify mispriced assets, he invests his own savings in index funds. The fact is, market anomalies exist and they deserve closer scrutiny, but thus far behaviorists are not even close to offering a substitute framework for modern portfolio theory as the basis for investing wisely.

* * * * *

Chuck Carlson's Latest Market Commentary

While the election results will be on everyone's mind, what will be the biggest factor for stocks going forward isn't who won the election. And it isn't what happens in Iraq or to oil prices.

Simply put, it's all about corporate profits.

Corporate profit growth in the third quarter for the S&P 500 stocks will be about 15% to 17%, not bad, but below the 20% plus growth of the predeeding four quarters. Corporate profit growth is slowing, and that is the main reason for the sluggish market.

Not the election.

Not oil prices.

Not Iraq.

Corporate profits.

I think the fourth quarter will see another deceleration in corporate profit growth, but I think the tide will turn by the second quarter of next year.

Since markets move about six months or so ahead of the profit results, look for a nice rally, perhaps toward the end of the year, and especially in the beginning of 2005.

-Per Chuck Carlson
November 2, 2004

* * * * *