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Power Ratings Revisited

George C. Fisher

It has been a while since I completely updated my old Power Investing with DRIPs stock list. As this weekend is snowy, cold, with the customary gale force Northeast winds, and with the economy emerging from a 3-year funk, I thought it would be a great opportunity for a stroll down memory lane. I dusted off a spreadsheet dated February 2, 2002 and began filling in the numbers.

Many hours later, I ran the anticipatory “data sort” function, and up came the latest order for investing preferences.

For those who either were subscribers to Power Investing w/ DRIPs but have forgotten the premise and for those who failed to send their $99 annual subscription fee, let me review the goal of this exercise.

Power Ratings is a formula-driven ranking system. It incorporates several different fundamental and analyst based facts and opinions. These include:

Anticipated next year’s earnings, to me, is key in evaluating current stock prices. As a long term investor, I am more concerned about the future of the company than its past. Ditto for Anticipated 5-year EPS growth. While these are admittedly mere “guesstimates”, they provide an insight into what others are thinking.

While not considered the ultimate in stock nor market picking, overall broker consensus also facilitates in understanding where the “pros” are recommending new investment dollars. Using a 1 to 5 broker rating system, it is easy to determine a level of interest in a specific stock. However, for my consideration, the number system really converts to a 1 to 3 ranking, when the bottom levels of 4 (sell) or 5 (strong sell) are rarely used. I like to find companies that are above a 2.5 consensus rating. I don’t emphases any single recommendation, just the consensus. Most of the time, consensus ratings will fall in the 1.5 to 3.0 range, with numbers lower than 1.5 usually come from a low number of analysts and numbers higher than 3.0 reflecting extreme sediment.

As with all crystal balls or tarot card readings, it is best to revisit these numbers often as they do change.

The previous three-year average annual dividend growth rate utilizes 5% annual dividend growth as its benchmark, with subtractions for below or additions for above a 5% growth rate.

Deductions are calculated for lower S&P Equity ranking. B+ rated companies needs to have higher fundamentals than A+ rated companies to offset the inherent higher risk. Not Rated (NR) carries the highest deduction, as it usually implies the company does not have a 10-year history as a public company or is based overseas. Utilities and REITs receive a handicap, as their PEG ratios and EPS growth is inherently substantially below other economic sectors.

Companies start with a rating of 100, and then the S&P handicap is deducted. PEG ratios and broker consensus are factored in, and additions or subtractions are made for dividend growth. Power Ratings favor companies with low 2004 PEG ratios, high broker consensus and decent dividend growth.

Debt to Equity, 3-year average return on equity and 3-year average return on capital are calculated as non-formula data.

The top three Power Rated companies in each economic sector (based on the old eight sectors, not the new ten sector format):

The best 3-year return on capital, by sector, are:

Observations:

There were a very large number of 5-year EPS growth rate revisions, and it was not pretty in most cases. For example, Nokia NOK saw its growth rate slashed 41percent, from 17 percent annual growth to 10 percent. Century Telephone CTL went for 11 percent to 6 percent anticipated growth. Intel INTC went from 16 percent to 11 percent anticipated growth. These revisions have a huge impact on calculations for PEG ratios and current stock valuation considerations.

Most businesses have been in terrible shape for the past few years. This will have an impact on return on equity and return on capital ratios. With an expected upturn in profitability, these numbers should rise over the next few years. Some companies have much lower 3 year management efficiency ratios than their historic 5-year and 10-year averages. Many in this situation will see gradual improvements back to normal levels. That being said, what better time to critically judge management than at the end of a really bad spell.

PEG ratios are higher now than in Feb 2002. A combination of a current rebounding stock market, earnings lags and reduced growth estimates, finding stocks that trade under a 2004 PEG ratio of 1.0 is difficult.

Data is provided in a sortable excel spreadsheet (minus the formula, of course) of the 120 or so companies I follow.

The first 20 stocks are considered “Full Speed Ahead”, the next 25 are considered “Power Up”, with “Neutral”, “Power Down” and “Throw Overboard” filling in the rankings.

There seems to be a larger number of banks recommended than I would like to see. With the potential for rising interest rates over time, bank stocks and high dividend paying stocks would traditionally be venerable.

Important note: Power Ratings are a momentary snapshot of current sediment and stock value. As these change, either for the better or worse, the impact on power ratings can be substantial. Earnings estimate revisions upwards or downwards impacts broker recommendations and PEG ratios. When I was active in the newsletter business, I updated these numbers on a consistent basis, and would also include a column for changes up or down.

It is important to diligently research each stock and management you are considering. This list is provided strictly as a springboard for generating additional ideas and these investing preferences reflect my personal investing bias.

Current Spreadsheet

George Fisher, author of The StreetSmart Guide to Overlooked Stocks (McGraw Hill, 2002) and All About DRIPs and DSPs (McGraw Hill, 2001), Sagamore Beach, MA

Copyright North Shore Associates 2003