Predictive Play

Last modified 09:58, 5 Nov 2012

Predictive Play

The Predictive Play analysis model is in the Growth group of fundamental analyses.

The Predictive Play model recognizes that money lost is money that's hard to recoup. Accordingly, the model searches for stocks that meet a long host of earnings criteria.

Quarterly earnings, for example, should be positive and growing faster than they were (a) a year ago, (b) in the preceding three quarters, and (c) over the preceding three years. Annual earnings should be up for at least the past five years. And sales should be growing as fast as or faster than earnings, since cost-cutting and other non-revenue-producing measures alone can't support earnings growth forever.

Finally, the Predictive Play Model requires that companies have a price-to-earnings ratio of at least 5—to weed out weak companies—but no more than three times the current market P/E or 43, whichever is lower.

This strategy makes sense for investors who like the potential of growth companies but are not willing to pay premium prices for them.

Analysis / Calculation

The following are some of the criteria used in the Intelligent Investor analysis:

The four relevant criteria are:

Price / Earnings Ratio (P/E) within Acceptable Range

P/E ratio is a popular indicator of a stock's value. It is calculated by dividing the stock price by the Earnings-per-Share (EPS).

A low PE ratio stock is often viewed as cheap or unpopular whereas a high PE stock is often viewed as expensive and popular.

In order to eliminate weak companies, Predictive Play eliminates companies with a PE less than 5. The model also eliminates companies with a PE greater than 43, or greater than 3 times the market's PE, as they are seen as too risky.

A PASS is a stock with a PE between 5 and 43 and no more than 3 times the market's PE.

A FAIL means that the stock's PE is either too low or too high or above 3 times the market average.

Revenue Growth not Substantially Less than EPS Growth

For earnings to grow over time, earnings must be supported by growing revenue.

Predictive Play requires that revenue growth should not be substantially less than earnings growth.

A PASS reflects a stock with a revenue growth/earnings growth of 30% or more.

A FAIL indicates that the stock does not have a high enough revenue growth.

Accelerating Sales Growth Rate

The Predictive Play analysis looks for sales growth for the current period relative to the same period a year earlier.

A PASS reflects a stock with a rate of quarterly sales growth accelerating.

A FAIL indicates that the stock has a rate of quarterly sales growth that is either flat or decelerating.

Stable Earnings per Share Growth

To ensure that the company is growing, the following checks are conducted:

  • Current Quarter EPS Growth is positive
  • Quarterly Earnings from one year Ago are positive
  • Positive EPS Growth rate for Current Quarter
  • Positive EPS Growth rate for past several Quarters

Earnings Acceleration

To ensure that the company is growing, the following checks are conducted:

  • Current Quarter EPS Growth is greater than the average of the past three quarters
  • Current Quarter EPS Growth is greater than the historical (last 5 years) growth rate

Long term Earnings Persistence

Earnings persistence refers to the company's ability to growth earnings from year to year.

A PASS result is given to a stock if it has increased earnings from year to year for the last 5 years.

A FAIL is given if the stock has not increased earnings for the last 5 consecutive years.

Note - Although one year of zero EPS growth is allowed, Predictive Play requires companies earnings to increase from year to year.

Long Term EPS Growth at least 15%

To ensure that the company is a growing company, the long term earnings growth rate must be at least 15%.

A PASS is given if a stock's 5 year earnings growth rate is 15% or more.

A FAIL is given if a stock's 5 year earnings growth rate is below 15%.

Total Debt/Equity (D/E) Ratio Above Industry Average

Companies like this are usually net borrowers of money. The debt to equity ratio measures how much debt the company has compared to shareholders equity. The debt to equity ratio is important in gauging a company's financial stability. If debt to equity is too high then the company may run into financial difficulty. If it is too low, it may indicate that the company is foregoing possible opportunities to create more return to shareholders. The ratio is calculated by taking total debt and dividing it by shareholders equity.

A PASS is given if the stock's debt to equity ratio is below the industry's average.

A FAIL is given if the stock's debt to equity ratio is equal to or above the industry average.

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