Sometimes when opening up a new stock and applying Toolkit's judgment from the First Impression screen, you may see that the Sales or EPS estimates are filled in with zeroes. Here is a plain English description of the selections that Toolkit 6 makes, and how that can happen.
Sales and EPS growth are projected at the lower of the last 9-year or last 1-year historical rates. For the most part, this means that if a company has a bad year, the EPS will be listed as having zero projected growth. You may also see cases where the historical "weight" of several bad years can outweigh a single good year of sales or Earnings.
As well, EPS is never projected to grow faster than sales. This means that if the sales for a company are projected to have zero growth, then the EPS will show the same, even if the Earnings have gone up during the same time period.
The projected high P/E ratio considers the average high P/E Ratios of the last five years on a weighted basis eliminating the highest high P/E Ratio and is capped at 30.
The projected low P/E ratio considers the average low P/E Ratios of the last five years on a weighted basis eliminating the highest low P/E ratio and is capped at 20.
The projected low price is by default the projected low P/E ratio times TTM EPS, but will never be higher than 80% of the current price.
For more on this, Doug Gerlach gives the following example:
In the examples following, Toolkit 6 projects future growth of sales and EPS at 0% for both Johnson & Johnson and Amgen, Inc. even though both have positive 10-year growth for both sales and earnings.
Let's take a closer look at both companies. JNJ's 10-year average annual sales growth rate is 9.4%, with annual EPS growth of 12.9%. AMGN has annual sales growth of 19.2% over the past decade, with EPS growth of 20.0%. Those are quite respectable for large companies the size of Johnson & Johnson and Amgen. So how does Toolkit 6 justify no future growth?
Here are the sales and earnings histories for the past decade for both companies, first for JNJ:
and then for AMGN:
It's apparent from the Visual Analysis graphs that both companies have had persistent EPS growth over the past 10 years.
If you look at the sales growth from 2008 to 2009, though, you'll see a different story. Both companies saw sales decline in sales for that period. And so Toolkit 6 refuses to project any future growth for those businesses.
Toolkit 6 is really just following the rules that BetterInvesting members have been taught all along: that earnings can't grow over the long-term if sales don't grow, and if a company hasn't grown EPS and sales consistently in the past, what makes you think they can in the future?
Of course, just because Toolkit 6 is unconvinced that these two companies won't see growth in the future doesn't mean that you can't override the default judgment. In fact, that's what we expect users to do if their research shows that past results are somewhat anomalous and are unlikely to recur. Your stock studies are only as good as the work that you do to evaluate a company's quality and growth potential.
One final observation: If you take a look at the Historical Growth Rate graph from the Visual Analysis screen (it's the icon labeled "Hist. Growth" on the toolbar), you will see the change in the rates of growth over the past 10 years. For JNJ, the graph looks like this:
And for AMGN, the graph looks like this:
This graphs and tables indicate that the growth of sales and earnings for both companies has been consistently slowing down over the past 10 years. Except for Amgen's uptick in EPS growth in 2009, both companies have been growing more and more slowly until they reached the point where sales actually started to shrink.The question that investors have to answer -- as Toolkit 6 demonstrates -- is whether or not the path to future growth is clear enough to warrant investing at this time. That's the key to applying judgment to any stock investing decision.