Demo 3 - Forecasting Calculator with F.A.S.T. Graphs. Transcript for video located at:

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1 Demo 3 - Forecasting Calculator with F.A.S.T. Graphs Transcript for video located at: This FAST Graphs, Demo Number 3, will look at the FAST Graphs forecasting tools and review how to interpret and utilize them properly. There are two primary FAST Graphs forecasting tools. The first is the Estimated Earnings and Return Calculator, which we call the forecasting graph, and the second is the 10-year earnings yield estimator. When initially drawn, both of these tools default to the consensus estimates of leading analysts reporting to Standard & Poor s Capital IQ. All the subscriber has to do is type in the stock symbol and hit the Go button and the FAST Graphs will automatically be drawn. It s important that the FAST Graphs subscriber understands that these are estimated earnings and return calculators, and tools that simply are doing calculations based on these analysts estimates. As you will see a little later in the demo, there is an override function where the subscriber can add their own estimates if they disagree with the consensus estimates. The Estimated Earnings and Return Calculator is simply that, it s a calculator. It defaults, as we previously mentioned, to the consensus of leading analysts reporting to Standard & Poor s Capital IQ. There are two forms of forecasts that are displayed in the Estimated Earnings and Return Calculator. First, precise earnings estimate numbers are given for up to four fiscal years. For instance, when looking at McDonald s (MCD) you can see that the next 4 years of forecasted data include: $5.86, $6.33, $6.92 and $7.68. You will also notice that growth rate for each year is displayed underneath the EPS estimates. After the given earnings estimates which can include up to 4 years of data - F.A.S.T. Graphs uses the consensus long-term estimated growth rate that analysts provide. Here we can see that analysts are projecting an 8% growth rate for McDonald s. Consequently the 2018 and 2019 EPS estimates utilize this 8% growth rate. Our second example, Aaron s Inc. (AAN), gives a little more clarity to what we ve just pointed out. This year s consensus estimated earnings are $1.87 representing a 13% growth rate over 2013 s actual $1.65. Then there is a consensus forecast of $2.02 for next year which represents an 8% growth rate from the $ followed by estimates of $2.36 and $2.59 for 2016 and After the 2017 estimate, the EPS estimates are grown by the long-term growth rate of 8.5% - which is rounded to 9%. Logic would tell us that the closer the estimate is to the actual time frame, the more precise it might be. So when you are looking at these estimates, we tend to suggest that the subscriber focus more on these first two years, the current year we are in and the next year s estimate, and less on going out three to five years. However, we do believe that all of these numbers collectively provide a reasonable proxy for what you might expect from a given company in terms of its future earnings

2 growth, not just because it s based on consensus analysts, but also because a significant portion of this number can be provided by guidance from the company themselves. When interpreting how to use this graph there is a couple little tips and tricks that we want to point out. First of all, we want you to notice that since this is an estimate, we believe that it will be reasonable and rational, but we could never expect it to be perfect. Therefore, FAST Graphs automatically creates what we call a value corridor. We supply two orange lines above and two orange lines below the consensus estimate line. So the idea is the subscriber should realize that these numbers represent hopefully rational expectations, but they shouldn t be thought of as absolutely precise. Any time the stock price is within these orange corridors it would theoretically be at a reasonable value. Of course, if it s within the two above as it is with Aaron s, you can argue that it s moderately fully valued to even slightly overvalued, and of course, if you saw the price at these two bottom orange lines, you can argue that the stock was significantly undervalued, all of that of course based on what the consensus estimates for this year, next year, and then the three to five-year period following that actually are. But the point is, we are trying to provide a range of reasonableness here, and then the additional blue lines just provide different PE ratios, and you can look at the scale to the right of the forecasting chart and see what these lines represent. For example, the bottom line in this example represents seven and a half times earnings. The top line would represent 22.5 times earnings. So what we are saying is that if the price earnings ratio expanded from its current 17.8 PE ratio, which you can see that very clearly in the fact that it s between these two orange lines right here, and the PE expanded up to a 22.5 multiple, then the stock would be closer to $42. And you can do that by just pointing to any of these dots throughout this graph. So if you go to the final dot here, what we are simply saying is that if the stock traded at 15 times earnings, then the target price would be $45.74, assuming that earnings came in exactly as this chart was drawn, and that would represent a 7.8% compounded annual return which would include dividends, if any. For clarity, let s look at a company that has a slightly higher dividend yield - Deere & Company (DE). This is an interesting example because I want you to notice that the consensus is forecasting a 10% drop, earnings going from $9.35 to $8.43 over the last completed fiscal year, and also notice that the diamonds indicate that Deere has an October 31st fiscal year. Moreover, earnings are expected to drop again in the following year by roughly 8% - before reaching a stable level of earnings. You can also see that Deere has a moderate to average expected long-term growth rate of 6%. Yet because the price is below the orange line and the company pays a dividend, the estimated return is greater than the estimated earnings growth rate. This particular graph is forecasting that if you went out here to 12/31/2019 your price would represent $ that target price would represent a 9.8% compounded rate of return that also included dividend income. Let s now move on to the original McDonald s example we used and look at the 10-year earnings yield estimate, or what we like to call the EYE chart, earnings yield estimator chart. This chart is a

3 mathematical representation of the picture of the estimate earnings and return calculator, and since McDonald s has a calendar fiscal year this will make it a little easier to present here. McDonald s has a target estimated annual total return of 9.1% which indicates that if McDonald s grew earnings as expected, it s target price on 12/31/2019 would be $ times the estimated 2019 EPS number. If you add in dividends, which would equal a 9.1% compounded return. When we examine the EYE table, we see that number expressed. In order to state this a little more clearly we want to point out that the value that you see by hitting this diamond out here at the end of the fiscal year that pops up, in this case 12/31/2019, a price of $134.37, is the same value you see in the brown cell on the same date down here on the EYE chart, the Earnings Yield Estimator chart. And what this says is, that if the stock trades at this valuation, assuming all these earnings estimates came to fruition, then you would average a 9.1 % compounded rate of return. If we look at the individual years, the Earnings Yield Estimate table simply demonstrates the math behind the Estimated Earnings and Return Calculator. In this example, McDonald s is expected to grow earnings by 7% to reach a 2014 EPS number of $5.86. If the stock were to trade at 15 times earnings, this would represent an $87.84 price at year-end in comparison to its current per share price of $ This would represent a negative 5% compounded annualized rate of return. Note however, that this is only looking out for the next 9 months and is defaulting to a 15 P/E ratio. In the following year McDonald s is expected to grow earnings by 8% to $6.33 which would put the value at $94.88 which again you see in this cell, that would represent a 3.7% compounded annual rate of return from this point to this point. Then so on and so forth as you go up the scale and hit these different diamonds here and get these different pop-up windows you would see that the numbers correspond to what you see on the EYE chart below, $ would represent a 6.7% compounded annual rate of return, assuming all these estimates were correct and the numbers came out precisely as they were forecast. Now another point that s very important that I mentioned earlier in the demo video, you also have the ability to override the estimates. For example, if you thought a 8% growth rate was too aggressive and McDonald s was only going to grow at say 5%, you could type the number 5 here in the override growth rate estimate, redraw the McDonald s chart by hitting the Go button at the top or the bottom of the navigation bar, and now you ve redrawn the chart with your own theoretical earnings growth rate. You still have the same estimates for the first 4 years, but from this point forward notice that you are only growing earnings by 5% a year, and of course, that changes all of your factors and allows you to say okay, what if it only grew by 5%, then my target rate of return would be lower at 5% growth than it would be at 8% growth, and vice versa. You could put in 15% growth if you thought the numbers were overly conservative. Additionally, you have the ability to override specific years in the same place as you override the growth rate estimate. We also provide a link to other estimates that enables you to compare our estimates to other sources. This can be viewed by clicking the link To find other estimates or symbols.

4 We have just a few other comments about the Earnings Yield Estimate table, remembering that it s the mathematics behind the Estimated Earnings and Return Calculator -- it takes this picture here and simply converts it into numbers. The first cell shows how many shares you would have bought by investing $10,000 at the current price. The first green column shows the estimated earnings per share for each year. These are the same numbers that can be observed underneath the Estimated Earnings and Return Calculator. Expected dividends per share are shown in the second column. The third column represents the expected total earnings claim again using the starting number of shares as a multiplier these values are simply the expected EPS multiplied by beginning shares. At the bottom of this column, it totals the cumulative earnings over a 10-year period. The fourth column shows the earnings yield, and an earnings yield above a Treasury bond obviously would indicate that you ve at least got some compensation for the risk you ve taken. Then you have your current dividend yield, and this is growth yield. Some people refer to this as yield on cost. The total dividends are displayed in the sixth column, which based on the beginning number of shares you would have bought with $10,000 just like the total earnings column; the total dividends are cumulated at the bottom of this column. We have already discussed the seventh column Target Price and Estimated Total Return. Finally, the last two columns show the current 10-year Treasury rate and expected payouts, once again totaled at the bottom. This number can then be compared to both the cumulative earnings and total dividends. For instance, the total expected earnings is estimated to give you a 3.6:1 ratio to the Treasury bond in this example. In other words, if McDonald s hits all these estimated targets, the company would generate 3.6 times as much earnings as you would get in cumulative Treasury bond interest. Now, I ve put a picture up here of United Technologies (UTX), a company that appears to be trading at the higher end of the earnings corridor. I chose this example because I wanted you to see another aspect of the Earnings Yield chart. We show this company pays a dividend, but when the column is pink like it is here, this is indicating that it takes this many years, or it won t be until the year 2019, where the total dividends here would equal what you were getting in a riskless Treasury bond, and you get the same concept with yield and estimated dividends. So when you see the lines pink like this, this is simply saying that in the beginning your dividend yield is less than the yield on the Treasury bond, and the cumulative dividends would not equal what you would receive on the Treasury bond until year-end However, it s important to note that the dividends would begin exceeding a Treasury bond interest probably by 2017 when the yield was expected to be 2.8% versus the 2.6% of the Treasury bond. But that s why you see these different colored codes here to give you an indication of how long it s going to take you to become into parity with a 10-year Treasury bond. So that s the forecasting chart or the Estimated Earnings and Return Calculator in a picture and numbers. It s designed to help you make decisions. Remember, you can always run overrides and run your own calculations or as many what if scenarios as you would like, but the idea is to try to give you a sense of relative valuation along with how analysts are presently viewing the company.

5 This is the third video in a series of demos that illustrate the enormous power and benefits of the F.A.S.T. Graphs research tool. The next demonstration videos will cover the basics of how to use the Screening Function and How to Build and Manage a Portfolio using F.A.S.T. Graphs.