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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: straight life who wrote (42332)	5/2/2001 3:45:27 PM
From: Mike Buckley	Respond to of 54805

striaghtlife, I'm going to answer your question in a way that hopefully addresses issues that those less informed than you might appreciate learning about. what happened to make $120 and $48 so similar? Analysts numbers on the future of SEBL going down? I wish I had a record of the analysts' estimates and the historical trailing EPS in November when the price was $120. The data would allow a fascinating case study that would show how the various factors of a PEG ratio work in real time. Though I don't know the details, you're right that the growth estimate is a lot lower. If I remember correctly, the estimates in November implied about 40% annual growth. Today it's about 15%. (Estimates have been lowered more than 20% in the last couple of months.) Another big difference has to do with my contention with Thomas that spreadsheets alone don't solve the issues for those with math phobias. Understanding how to interpret and how not to interpret the results of the mathematical computations is critical. (Everyone knows that I know nothing about math. I came by my understanding by repeatedly creating scenarios and using trial and error to observe the impact the various factors of a PEG ratio have on the total results.) Sorry for digressing. :) In November there were no estimates for 2002. Anyone running a PEG ratio was using estimates going forward only five quarters. In early January, we had estimates going forward five quarters from the date of the historical PE but it was covering a span of time that ended less than 12 months away (from early January to the end of December.) Due to the fact that annualized rates of growth can, though not necessearily, be very misleading when calculated over such a short period of time (I'll explain below), it's possible that the estimated growth relative to the historical PE was skewed. The role of the annualized growth rate in PEG ratios is more accurately served when there are at least 6 or 7 quarters of growth being estimated and eight periods is ideal. (To put that idealistic situation into perspective, we have estimates going forward 8 quarters for only about six weeks each year.) Anything less than that can be skewed a lot, especially if there is a cyclical nature of the revenue stream. As an example, assume that we've got estimates going forward only five quarters for a company that has an exceptionally strong fourth quarter. Also assume that the fourth quarter is covered twice in the estimated period. That skews the numbers because the unusually strong quarter is being considered twice -- 40% of the estimated period -- when in the total business cycle it occurs only 25% of the time. Another factor has to do even less with the fundamentals and entirely deals with the math. Using an example that serves the purpose by blowing everything out of proportion, I'll try to explain how a short period of time can produce an annualized rate of growth that is completely meaningless. If a stock portfolio is valued at $1000 one day and is valued at only $10 more the next day, it's annual rate of growth (compounded annually and using a 365-day year) is 3678%. Yep, 3678%!!!!!!! We know the likelihood that the portfolio will continue to grow at 1% per day on average including the days the market isn't open is virtually zero. If we didn't know how unlikely that is to happen, we would have reason to get excited about that 3678% annualized rate of growth. Nonetheless, the computed annualized rate of growth is accurate. The flaw would be to think that the accurately calculated growth rate is an indicator of anything meaningful to the investor considering the short period of time (only one day) that was used to compute the calculation. Similarly though to a lesser extent, when we compute the annualized rate of growth that is inherent in a PEG ratio over a short period of time, it can be deceptively misleading to the investor. I suspect that last element partly explains why Siebel's PEG ratio is about the same today even though the price is about 60% lower. In November, we were working off estimates going foward five quarters. Today, they cover 7 quarters. If you take the time to change the time being addressed in a financial calculator or a spread sheet, you'll see that the difference between five or seven quarters is significant enough that it needs to be understood by the serious investor using annualized rates of growth when running valuations. Like I mentioned a couple of days ago, understanding valuations is dry and not easy. But no one ever said investing in common stocks is easy, which is another subject I'm going to be ranting about over the next few years especially during euphoric times. --Mike Buckley