The most important activity of an investor is to be able to estimate with confidence the profit rate on buying stock in a company and holding it for your investment time frame. And you want to be able to do this based on numbers that you can see and adjust such as the growth rate of earnings.

You can do this and more in a few minutes with the Valuesoft Investment System.

Valuesoft provides essential tools for investors of all levels, from those just getting started to the most experienced professionals.

The building blocks of Valuesoft are investment functions. You can use these functions on their own. Or you can use them to build templates to suit your own needs. With these functions and templates you will be able to focus on the important aspects of investing and not get hung up on jargon, rumors, and complex calculations.

All the functions are clearly explained in the manual along with examples of different types of templates. The following is an example of how to use three of the Valuesoft functions to analyze a company.

Let's do an analysis on Johnson & Johnson, the health care product company. After having done some research on the company (its products, competitors, and so on), you are ready to crunch some numbers. This is where the Valuesoft Investment System comes in. We will look at three different templates each using a single function from Valuesoft:

• Stock Return using STRETD
• Stability using STAEGR
• Intrinsic Value using DCF2S

(For an example of an Australian company, click here. For Level 2 templates, click here.)

1. Stock Return using STRETD

Suppose you are interested in estimating the percentage return on buying JNJ now and holding it for 5 years. You will need some data which you can get get free from most of the major investment sites such as Money Central  or Yahoo Finance. When you use these sites, you may have to go to different pages to collect all the information that you need.

For Yahoo Finance all the data we need is on the Summary page and the Analyst Estimates  page for each company. The URL for these pages for Johnson and Johnson are:

• http://finance.yahoo.com/q?s=JNJ (Summary page)

• http://finance.yahoo.com/q/ae?s=JNJ (Analyst Estimates page)

• http://finance.yahoo.com/q/ks?s=JNJ+Key+Statistics (Key Statistics Page)

You might find it easiest to print these pages before you start. The following is the list of the required data and the page where you can find it. (More details of these terms can be found in our glossary: click here. For the financial glossary at Yahoo, click here.)

Current price: this is the last price at which the stock was sold (Profile page)
Earnings per share trailing 12 months (EPSttm): the total earnings of the company over the previous 12 months (four quarters) divided by the number of shares outstanding (profile page). Think of this as the amount of money that the company is earning on your behalf for each share that you own (Profile page).
Projected price to earnings ratio (P/E ratio): as an estimate of the future P/E ratio we will use the current P/E ratio which is the current price divided by the EPSttm(Profile page).
Projected growth rate of earnings: this is a forecast of the average growth rate of earnings. Use the figure in the column "Next 5 Years" on the Analysts Estimates page even though you may have a longer time frame in mind. If you are not given a figure (perhaps because no analysts are following the company), enter the average percentage growth rate for the past 5 years. If this is also missing, then beware of investing in this company. With less than five years of data, it is very difficult to make any forecasts. (In the Level 2 Templates you will see how to avoid having to rely on analyst forecasts.) In the example of JNJ, I am just going to use the historical growth rate of earnings instead of relying on analyst forecasts.
Years: the time frame of your investment. Generally this will be 5 years or more.
Payout rate: this is the percentage of earnings that the company pays out in dividends. You can get this figure at the Key Statistics page, under the 'Dividends & Splits' table. You can also calculate it by dividing Dividend by Earnings per Share.

For things like the P/E ratio and the projected growth rate, don't worry too much about decimal places. It is likely that you will change them to more conservative figures when you have everything all set up. As first estimates just start with historical levels.

The last two requirements are:

Tax rate on dividends: this is your marginal rate of tax.
Tax rate on capital gains: for simplicity I will set these at 0% in the following examples.

Now enter this data into an Excel page to get something like shown in the following figure:

I have formatted some of the cells as percentages. Otherwise you can leave them as decimals.

In the cell I3 type =STRETD(A4,B4,C4,D4,E4,F4,G4,H4) and press return. (You don't need to use uppercase letters. And if you are more familiar with Excel, you can get the same result by using the function button and going to the function STRETD, which stands for STock RETurn with Dividends reinvested.)

When you have done this you will get:

In this case I have formatted the cell I3 as a percentage. If you did not do this you would get a decimal number. In this case I have put the cursor back into cell I3. Notice that =STRETD(A4,B4,C4,D4,E4,F4,G4,H4) has appeared in a box at the top of the page.

The number in the cell I3 is an estimate of the before-tax annual return by purchasing JNJ at the current price and holding it for 5 years.

The huge advantage of Valuesoft is that you can put in your own estimates of the growth rate and P/E ratio so that you can see exactly the effect on the final result. We will demonstrate this below.

Of course, the above only works when you have purchased and loaded Valuesoft. Without Valuesoft, you will get the result #NAME?

Margin of Safety
Remember,  none of the inputs can be totally accurate. It is up to you to adjust them to allow for a margin of safety and other outcomes of your investigations. (In the Level 2 Templates we show how Valuesoft has built-in functions for calculating a level of safety as a staring point for your own margin of safety.)

In the 1999 annual report of Berkshire Hathaway, Warren Buffett said that he employs "a range of values, rather than some pseudo-precise figure." With Valuesoft this is a snap since each time you enter a new number and press return, the answer is automatically recalculated.

For this simple case, we will just make an estimate of a reasonable margin of safety for the P/E ratio and the projected growth rate. The data and results are shown in the next figure.

This time the estimated after-tax return in Cell I1 is much lower. What this means is that under a margin of safety you will make at least this rate per year over the next 5 years. At the same time it leaves the upside open so that the final return could be much higher.

With more experience, you can do the above in a few minutes. Once you have set it up for a company, it is a simple matter to update that data as new information becomes available. We are looking for companies that give us a reasonable rate of return with a high level of confidence. Then, in practice, the actual return is frequently much higher.

STRETD is only one of the 30 functions in Valuesoft. One of my other favorite functions is TARGD. This calculates the price that you would need to pay to achieve your desired return. When you do this, you set yourself up to wait until there is a dip in the price. At that moment you can buy the stock you want at your price to get your return.

2. Stability using STAEGR

The importance of focusing on companies with high stability in the growth of earnings and sales is described in Chapter 13 of The Conscious Investor. This is done via a proprietary function called STAEGR. (It is pronounced stay-ger and comes from the expression "stability of earnings growth.")

Staegr measures the stability or consistency of the growth of historical earnings per share from year to year, expressed as a percentage in the range 0 to 100 percent. When applied to data over any number of years, high STAEGR corresponds to high stability and low STAEGR corresponds to low stability. STAEGR of 100 percent signifies complete stability, meaning that the data is changing by exactly the same percentage each year.12 The function has the feature of adjusting for data that could overly distort the result, such as one-off extreme data points, negative data, and data near zero. It also puts more emphasis on recent data.

The important result for us is that large-scale studies in the USA and Australia show that stocks with a high level of STAEGR are likely to have earnings that continue to grow in the future at the same rate as they grew in the past.

We particularly look for stocks that have STAEGRs of 80 percent or more for both their earnings and their sales. If a company does not satisfy this criterion, I usually just pass it by. After all, if there was little stability in sales and earnings in the past, then it becomes virtually impossible to make confident forecasts for the future.

The previous image shows how it can be used. The entry in cell C13 is calculated as "=STAEGR(C8:C12)" and calculates the stability of earnings per share over the 5 years.

Similarly the entry in cell C14 is calculated as "=STAEGR(C8:C12)" and calculates the stability of earnings per share over the 10 years.

3. Intrinsic Value using DCF2S

Calculating intrinsic value is a basic method used by many analysts. Usually it is based on the assumption that free cash flow will grow at a constant rate over a specified period (called the initial growth period) followed by a second constant rate over the remaining life of the business (called the terminal growth rate). These cash flows are then discounted back to present time. The sum of these discounted values is called intrinsic value and the method is called the discounted cash flow (or DCF) method. This method is discussed in detail in Chapter 7 of The Conscious Investor along with its strengths and weaknesses. The most serious weaknesses are based on the fact that the method requires forecasts to be made over infinite periods.

In Valuesoft the function DCF2S is a function that calculates intrinsic value using a two-stage approach. The following table is a simple example. The data is placed in cells A21 to E2. Cell F2 contains the entry "=DCF2S" and calculates the intrinsic value. Instead of free cash flow in cell A2, dividends, or any other financial measure can be used.

According to these calculations, the company is undervalued. However, as explained in The Conscious Investor, the results from discounted cash flow calculations are highly unstable. This means that just small changes in the inputs can give exceptionally large changes in the final value.

Note: Earlier versions of Valuesoft contained the function PRESVAL which combined a two-stage discount formula and a version of a three-stage discount formula. This has now been replaced by DCF2S for two-stage discounted cash flow calculations and DCF3S for three-stage discounted cash flow calculations.

Level 2 Templates Click here